Mint Explainer: How Sebi’s new proposals aim to curb risks in derivatives market

One of the key proposals is altering the method of calculating open interest (OI), which represents outstanding buy-sell positions in the derivatives market. 

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Sebi also plans to link the market-wide position limit (MWPL)—which caps the total open contracts in single-stock futures and options—to the average daily delivery volumes of the underlying stocks, replacing the current notional volume-based calculation.

The consultation paper invites public feedback until 17 March on additional proposals, including the introduction of pre-open and post-closing sessions for derivatives trading, revisions to position limits for individual entities in single-stock F&O, and new eligibility criteria for derivatives on non-benchmark indices to improve trading efficiency.

Mint examines three key proposals and their potential impact on investors.

How will delta-based approach for trading limits impact traders?

In March 2020, Sebi had imposed restrictions on short and long positions in index futures and options, capping net index positions at ₹500 crore. Under this framework, short positions in notional value could not exceed the participant’s holdings of the underlying stock, while long positions were limited by the participant’s cash or cash-like instruments.

The regulator now proposes revising these limits to reflect market growth. Sebi has suggested an end-of-day net limit of ₹500 crore and a gross limit of ₹1,500 crore for index options. For intraday trading, the net limit would be raised to ₹1,000 crore and the gross limit to ₹2,500 crore. These changes account for rising index levels and increasing trading volumes.

A major shift Sebi has proposed is adopting a delta-based approach to calculating trading limits. While notional values may make positions appear balanced, they can still carry significant delta risk, Sebi noted in its consultation paper on 24 February. 

Delta, in options trading, measures an option’s sensitivity to changes in the underlying asset’s price, ranging from 0 to 1 for call options and -1 to 0 for put options. For instance, an option with a delta of 0.5 means that for every ₹1 change in the stock price, the option price moves by ₹0.5.

Kunal Nandwani, co-founder and CEO of fintech firm uTrade Solutions, believes the delta-based approach aligns with how professional traders assess risk. He argues that this shift will help reduce unnecessary trading bans on stocks while maintaining appropriate risk controls. 

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However, Arpit Jain, joint managing director of Arihant Capital Markets, cautions that tighter position limits could restrict traders with larger portfolios, forcing them to restructure their strategies into smaller positions and reducing overall flexibility.

Shift in measuring open interest

Sebi has also proposed a fundamental change in how open interest is measured in the derivatives market. 

OI represents the total number of outstanding contracts—such as futures and options—that have not been settled or closed. It serves as a key indicator of market liquidity, with higher OI reflecting greater liquidity.

Currently, OI is calculated in notional terms by adding the number of new contracts created during a trading session and subtracting the number of contracts closed. 

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Sebi has proposed transitioning to a Future Equivalent (FutEq) or delta-based calculation, which would provide a more accurate measure of market exposure and risk. 

By adopting a delta-based OI calculation, Sebi aims to improve risk assessment, particularly for traders using options strategies. Experts believe this shift will offer a clearer picture of actual market risks, though it may require traders to adjust their strategies. 

According to Arihant Capital’s Jain, the current OI calculation method enables traders to manipulate stock prices, sometimes pushing stocks into unnecessary ban periods. The new approach, he argues, would prevent artificial position buildups and better align with real market risks.

“It adjusts for risk by counting only the actual price-sensitive positions in futures and options (F&Os). For example, if a trader holds deep out-of-the-money options (which have very little market impact), the current system still counts them as large positions. The new method would only count their real effect on stock prices, making the system fairer,” Jain said.

Recalibrating market-wide position limits

Sebi’s proposal to adopt a delta-based method for calculating open interest will also require adjustments to market-wide position limits (MWPL) in single-stock futures and options. 

MWPL sets a cap on the total number of open contracts in a stock’s F&O market and is currently determined as the lower of two factors: 30 times the average daily traded shares in the previous month or 20% of shares held by non-promoters. If a stock’s OI exceeds 95% of its MWPL, exchanges impose a trading ban until it drops below 80%.

Sebi now proposes recalibrating MWPL to better reflect actual market risk. Under the new formula, MWPL would be set as the lower of 15% of the stock’s free-float market capitalization or 60 times its average daily traded shares over the past three months. 

Sebi’s internal tests suggest this change could significantly reduce the number of stocks hitting the F&O ban period, bringing it down from 366 to just 27—a nearly 90% reduction. By making market manipulation more difficult, the regulator aims to create a more stable and transparent derivatives market.

Puneet Sharma, chief executive and fund manager at Whitespace Alpha, believes that incorporating Delta into MWPL calculations will help prevent instances where low-risk positions unnecessarily trigger market limits. 

This approach, he argues, will ensure that only significant market activities are moderated, allowing for smoother trading conditions. 

While the proposed changes could enhance efficiency, some traders might face challenges adjusting to the revised limits and margin requirements, potentially leading to higher transaction costs and increased compliance burdens.

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Despite these concerns, Sebi’s proposals are ultimately designed to improve execution efficiency for traders. 

Nirbhay Vassa, group chief financial officer at Abans Holdings, believes that these measures will facilitate smoother entry and exit in F&O positions with minimal price disruptions, making the market more accessible and predictable for investors.