In today’s Finshots, we talk about SEBI’s new rules for F&O trading.

The Story

Mr. Bull recently started dabbling in the equity markets. But it wasn’t long before he craved for bigger, riskier bets with bigger rewards. That’s when he stumbled upon the Futures and Options or the F&O market.

It seemed like the perfect playground. All he had to do was take calculated bets and trade in a type of agreement called a ‘contract’ that had set expiry dates, either weekly or monthly. If he expected the market to rise over the next week or month, he’d buy a contract. And if he expected a dip, he’d sell.

Soon, Mr. Bull moved on to trading NIFTY Bank in the F&O segment, where he could bet on whether the index tracking India’s banking sector would rise or fall.

He liked weekly contracts over monthly ones since they meant faster returns if he got them right. He even devised his own winning strategy. And things just went his way week after week.

But of course, getting started wasn’t cheap. Entering the F&O market required at least ₹5-10 lakhs as minimum investment. And since higher stakes meant higher rewards, he soon convinced a few investors to back him, offering them a share of the profits while keeping a cut for himself.

Everything seemed to be going perfectly until October 2024, when the game took an unexpected turn.

Market regulator SEBI came up with some big changes to how F&O trading works. And you could say that these new rules hit Mr. Bull’s fortunes hard.

That’s because for starters, SEBI decided to limit weekly contracts to just one major index per exchange, to curb their speculative nature. For instance, the NSE used to offer weekly options on various indices like Nifty 50 (NIFTY) and NIFTY Bank (BANKNIFTY). But now, it’ll only allow weekly options for one major index — let’s say NIFTY. This means that starting November 20th, Mr. Bull can only trade monthly contracts, leaving his NIFTY Bank trading behind.

That’s not all. SEBI also raised the minimum investment for index derivatives from ₹5-10 lakhs to ₹15-20 lakhs. This change means that Mr. Bull will need to shell out even more cash just to stay in the game.

On top of that, if he takes short positions, he’ll have to maintain an extra 2% margin as per the new rules on the contract expiry day to cover potential risks from increased volatility.

So suddenly, everything was different. Mr. Bull needed more capital. He had to rethink his entire strategy. And his weekly betting rhythm was broken. All that hard work, which had felt like building a steady business, now felt shaky. And he wasn’t alone. Many other traders like him voiced their concerns, calling these changes unfair to retail investors.

And their disappointment is understandable for many reasons.

First off, the F&O trading market in India is huge, with about 95 lakh traders playing a big role in keeping the market liquid. When entry requirements go up, it becomes harder for smaller traders to join in. This can lead to reduced liquidity, which might slow down the entire market. In fact, these changes could cut derivatives volumes by 20-25%.¹ And that could be a significant setback for the growth of Indian markets.

Then there’s the issue of shifting from weekly to monthly expiries.

Weekly expiries have been a favourite among traders like Mr. Bull because they deliver quick results. You place your bet, and in just a week, you know if you’ve hit the jackpot or not.

But with SEBI pushing for monthly expiries, traders will need to look for alternatives like options trading to chase quicker and higher profits. And while options trading might seem like an attractive substitute, it’s also way riskier. The reason is simple. Options have a high leverage and that means you control more with less money. But if your bet goes south, those losses can pile up fast. And ironically, this could spark even more speculative behaviour — the exact thing SEBI is trying to clamp down on.

But it’s not just the traders who are worried. Brokers are feeling the pressure too. That’s because they depend on high volumes of F&O trades to keep their brokerage revenues flowing. With fewer traders participating, their business could take a hit. And this could affect you as well! If brokers start earning less, they might raise brokerage charges or even cut back on investor-friendly initiatives like zero brokerage facilities.

Even fund managers who typically bet on weekly F&O expiries are scrambling to rethink their strategies in light of these changes.

Adding to the mix, these new rules might unintentionally favour BSE over NSE. Right now, NSE offers weekly expiries for four indices, while BSE has only two. With the new rule limiting NSE’s options, some traders might shift their business to BSE, potentially giving it a larger market share as traders search for other weekly options.

But wait… If these rules are shaking things up so much, why did SEBI come up with them in the first place, you ask?

Well, the answer lies in a recent analysis that uncovered some pretty alarming statistics.² It revealed that over 9 out of every 10 traders or 93% to be exact, lost money in F&O trading between FY22 and FY24. Yup, you read that right!

And guess who these traders are?

Mostly retail individuals.

Shockingly, over 75% of them had an annual income of less than ₹5 lakhs in FY24. And their losses are hard to ignore, which is why SEBI aims to protect retail investors from the risks of trading and the potential loss of their hard-earned savings with these new rules.

But here’s the catch. In trying to protect traders from heavy losses, SEBI might just be shooting itself in the foot. You’ll understand why we’re saying this if you look at what happened in Korea.³ Back in 2011, its regulators put similar rules in place, hoping to curb risk-taking in F&O markets. But the outcome wasn’t as sweet. F&O volumes fell and the market never recovered despite many attempts by the regulators to revive business activity. And even 12 years later these volumes are lower than in 2011.

So, could there be a better approach to all this?

Well, maybe.

Take the US, for instance. They have an assessment test that determines who can enter the F&O markets, ensuring that only those with the right experience, risk tolerance and understanding can trade. A similar approach could make more sense in India too, rather than simply raising entry requirements.

Education is another key factor. Instead of limiting access, there should be a stronger focus on educating traders about the risks involved. Because let’s be honest. Informed traders are often better at managing risk and making rational decisions.

And let’s not forget technology, which could also play a crucial role in improving transparency and accountability. In Australia, for example, many businesses have integrated blockchain to monitor various forms of derivatives trading more effectively. This provides a transparent and tamper-proof record of transactions, reducing the chances of market manipulation and enhancing trust in the system.

But all this said and done, one thing is clear. The Indian markets are evolving. And with each new regulation, the goal is to build a safer, more resilient environment for both investors and traders. Still, these changes can’t just take ten steps backward and just one step forward. The impact has to be positive for everyone in the game.

And only time will tell if that’s what we’ll really see. As for Mr. Bull?

He’s hoping to adapt to the new market. He perhaps knows it won’t be easy, but he’s got his eyes set on figuring out his next strategy. After all, that’s what good traders do, no? They adapt, they learn and they find new ways to succeed.

Until next time…

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Story Sources: The Daily Briefing [1], SEBI [2], Weekend Investing [3]

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