New Sebi Rules On Contract Size Likely To Squeeze Out Small Retail Traders

Small retail traders in the derivatives market are expected to face challenges as the Securities and Exchange Board of India (Sebi) introduces changes to the index derivatives framework, increasing the contract size. According to a Icra report, this move, aimed at enhancing market stability and investor protection, is likely to disincentive smaller retail traders and potentially lead to a 30 per cent decline in futures and options (F&O) trading volumes.

Sebi's new regulations, which will take effect in phases starting from November 2024, include increasing the minimum contract size for index derivatives from the current range of Rs 5-10 lakh to Rs 15 lakh, with a maximum contract value of Rs 20 lakh. These changes are part of broader reforms that include the upfront collection of option premiums, higher margins near contract expiry, and rationalisation of weekly index derivatives.

Impact On Smaller Traders
The increase in contract size is expected to significantly impact smaller retail traders, many of whom participate in the F&O segment with relatively low capital. In FY2024, around 75 per cent of F&O traders came from the low-income group with annual incomes below Rs 5 lakh. A vast majority of these traders incurred losses, averaging Rs 60,000, which represents a significant portion of their annual income. This has raised concerns over the appropriateness of their participation in such high-risk activities.

“While banks and institutional traders will adapt, the smaller retail segment will struggle to adjust to the new contract sizes,” noted the Icra report. Historically, when South Korea implemented a similar measure in 2012, increasing the contract size of KOSPI 200 options by five times, it resulted in a 76 per cent decline in trading volume.

Potential Dip In F&O Trading Volumes
The Icra report further predicts that the combination of these regulatory changes, along with the recent hike in securities transaction tax (STT), could cause F&O trading volumes to revert to 2022 levels, with an estimated 30 per cent decline across the market. Discount brokers, who derive 70-80 per cent of their income from F&O brokerage, are expected to feel the impact more acutely than full-service brokers, who have more diversified income streams.

Broader Market Stability Goals
These changes come in the wake of increasing retail participation in index derivatives, which has led to market volatility and significant retail investor losses. Sebi’s measures aim to curb speculative hyperactivity in the derivatives market, with an additional focus on protecting the retail investor. Other initiatives include enhancing margin requirements, reducing leverage, and rationalising weekly index options to manage risk effectively.

The changes are expected to be fully implemented by April 2025, reshaping the landscape for F&O traders, especially smaller retail participants. While the reforms aim to ensure market stability and investor protection, the increased contract sizes and other restrictions may limit access for smaller players in India’s growing derivatives market.