Why in the News?

The Securities and Exchange Board of India (SEBI) has introduced six new regulations aimed at reducing retail participation in the high-risk Futures and Options (F&O) market.

What’s in Today’s Article?

• About F&O (Derivatives, Futures, Options, Examples, Differences, etc.)
• News Summary

About F&O:

• Futures and Options (F&O) are derivative financial instruments that derive their value from an underlying asset, such as stocks, commodities, or indices.
• They are widely traded in the Indian stock market, primarily on exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
• Understanding F&O is crucial for investors looking to hedge risks, speculate, or enhance portfolio strategies.
• In India, F&O trading is regulated by the Securities and Exchange Board of India (SEBI).

What are Derivatives?

• Derivatives are financial contracts whose value is dependent on an underlying asset, which can be equities, indices, commodities, or currencies.
• F&O are the two most popular types of derivative contracts in India.

About Futures:

• A futures contract is a legal agreement to buy or sell an asset at a predetermined price at a specified future date.
• Both the buyer and the seller are obligated to complete the transaction at the agreed price, regardless of the current market value at the time of the contract's maturity.
• Key Features:
  • Standardized Contracts: Futures contracts are standardized in terms of quantity, quality, and delivery time.
  • Leverage: Investors can trade large amounts of assets by putting down a fraction of the value, known as margin. This offers leverage but also increases risk.
  • Mark-to-Market: Futures contracts are marked to market daily, meaning profits and losses are calculated at the end of each trading day.
  • Settlement: In India, most futures contracts are settled in cash, but certain commodity futures might involve physical delivery.
• Example:
  • If you buy a Nifty 50 futures contract at 19,000 and the market rises to 19,500 by the contract's expiry, you profit ₹500 per unit.
  • Conversely, if the market drops to 18,500, you incur a loss of ₹500 per unit.

About Options:

• Options contracts give the holder the right, but not the obligation, to buy or sell an asset at a predetermined price before or on the contract’s expiry date. There are two types of options: Call options and Put options.
• Call Option:
  • A call option gives the buyer the right to purchase the underlying asset at a fixed price within a specified time frame. This is used when investors expect the price of the asset to increase.
• Put Option:
  • A put option gives the buyer the right to sell the underlying asset at a predetermined price within a specific time frame. Investors use this when they expect the asset's price to fall.
• Premium:
  • In both call and put options, the buyer pays a premium to the seller (writer) for the right to exercise the option. The premium is the cost of purchasing the option.
• Example:
  • Call Option: Suppose you purchase a call option on Reliance stock with a strike price of ₹2,500. If Reliance’s stock price rises to ₹2,700 before the option’s expiry, you have the right to buy it at ₹2,500, gaining ₹200 per share.
  • Put Option: If you buy a put option for the same stock with a strike price of ₹2,500, and the price drops to ₹2,300, you can sell it at ₹2,500, making a profit of ₹200 per share.

Key Differences Between Futures & Options:

Sebi Tightens F&O Rules:

• The Securities and Exchange Board of India (SEBI) has introduced six new regulations aimed at reducing retail participation in the high-risk Futures and Options (F&O) market. The changes include:
  • Raising the minimum contract value to ₹15 lakh,
  • Requiring upfront payment of options premium,
  • Limiting weekly expiries to one per exchange, and
  • Increasing margins as contracts approach expiry.
• The regulations will be implemented in phases, with the first set of changes, including higher contract sizes and a 2% rise in loss margin for short options on expiry day, taking effect on November 20, 2024.
• Additional measures like the removal of calendar spread benefits will begin on February 1, 2025, and intra-day position limit monitoring will start from April 1, 2025.
• These actions follow concerns raised by the Reserve Bank of India (RBI) and the Finance Ministry about retail investors losing substantial household savings in speculative F&O trades.
  • A SEBI study revealed that 93% of retail traders suffered losses averaging ₹2 lakh in the past three financial years, contributing to a total net loss of ₹1.81 trillion between FY22 and FY24.
• While the regulations aim to enhance market risk management and curb speculative behavior, brokerage firms and stock exchanges are expected to face a reduction in F&O trading volumes by 30-40%.