SEBI’s New Index Derivative Framework Goes Live Today – Margin Changes Explained

Today marks the start of a significant change in the Indian stock market as the Securities and Exchange Board of India (SEBI) introduces a new framework for index derivatives. This move has already caught the attention of traders, particularly those involved in options selling, as they witness considerable changes in margin requirements.

The key clause that goes live today is the “Increase in tail risk coverage on the day of options expiry.” This means the Extreme Loss Margin (ELM) for all index derivative contracts expiring on the same day will increase by an additional 2% for the option seller with existing open position as well position initiated during the day that are due for expiry on that day, effectively raising ELM from 2% to 4% and overall margin from 11% to 13% for ATM contracts.

If you haven’t left a buffer in your margin account already, it’s suggested to add additional funds for Nifty's 21st November expiry. This new rule will apply to Sensex on 22nd November and so on.

Now, let's break down these changes and do the maths.

What’s Changing with Margins?

Traders will now see an additional margin requirement of 2% on their positions in index contracts.

While 2% might sound like a small number, its impact can be much more significant depending on your position. Let's do some math to understand this better:

Say for example, the Nifty index is trading at 24,000, and the lot size is 25. The total contract value comes out to be ₹6,00,000. Now, under the old regime, the margin requirement for an at-the-money (ATM) contract at 12% would have been ₹72,000. Now, with a 2% increase in margin on expiry day, the new margin requirement becomes ₹84,000. This represents around a 16%-17% increase from the previous figure.

These are broad numbers and the exact amount may be a bit lower/higher.

The critical point here is that the margin increase is not a simple percentage increase of the previously blocked margin; it is an absolute increase of 2% on the notional value of the contract.

This is where many traders are experiencing a significant jump in their margin requirements, especially those dealing with OTM options where the previously blocked margin was relatively lower.

Impact on Out-of-the-Money (OTM) and In-the-Money (ITM) Contracts

For OTM contracts, the impact of this change is more noticeable. In the old system, margin requirements would reduce as you go further out of the money. For example, if an ATM strike had a margin requirement of 12%, OTM strikes could have margins as low as 11%, 10%, or even 8%. Now, with an absolute 2% increase in margin based on notional exposure, the percentage increase for OTM contracts can be very steep.

For ATM strikes, margin might rise from ₹72,000 to ₹84,000, a 20% increase. However, for a ₹22,000 OTM strike, the margin jumps from ₹37,000 to ₹50,000, a 35% increase.

The more the option is out of the money, the increase will be even steeper.

Conversely, for ITM strikes, the increase will be less than 20%.

Now, Why is SEBI Doing This?

The new margin framework is part of SEBI’s broader initiative to rationalise risk and reduce excessive retail participation in index derivatives. By increasing the margin requirements, SEBI aims to ensure that traders maintain adequate funds to cover potential risks, particularly on volatile expiry days. This move is expected to discourage speculative positions, especially those with insufficient backing, thereby stabilising the market.

Impact on Trading Volumes

This change could impact trading volumes as higher margins make large positions less appealing, especially in OTM options. Market activity may decrease for a short-term as traders adjust to the new norms.

Also, many traders operating on tight margins might face shortfalls, requiring extra funds to maintain positions, potentially pushing some retail traders out or limiting their participation.

Rationalisation in the Market

The changes introduced by SEBI are aimed at rationalising the market and ensuring a healthier balance between risk and reward. By increasing the cost of taking speculative positions, SEBI is encouraging traders to be more prudent and ensuring that only those with adequate risk tolerance participate in the derivatives market.

While this may lead to a short-term dip in volumes, it is expected to bring more stability and reduce the chances of extreme volatility driven by over-leveraged positions.

To Wrap Up

As traders adapt to these new rules, we might see a period of adjustment where volumes could dip, but the long-term effect is expected to be positive for market stability.

For those involved in options trading, it is very important to reassess risk management strategies and ensure adequate capital to meet these new margin requirements.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

Investments in securities market are subject to market risks, read all the related documents carefully before investing. Brokerage will not exceed SEBI prescribed limit. The securities are quoted as an example and not as a recommendation. SEBI Registration No-INZ000200137 Member Id NSE-08081; BSE-673; MSE-1024, MCX-56285, NCDEX-1262.