 "Ease of doing business: Sebi mulling new metrics to measure risk in F&O")
In its next series of steps towards safeguards in the derivatives segment, the Securities and Exchange Board of India (Sebi) is mulling risk management measures by considering futures equivalent instead of open interest for risk metrics.
Sebi’s whole-time member Ananth Narayan on Saturday said that the regulator is exploring the transition towards future equivalent metrics, which may also lead to a review of the current market-wide position limit of 20 per cent.
However, the official clarified that these measures are towards ease of doing business and will not be further curbing the activity in the futures and options market.
“We are in no hurry,” he stated, adding that Sebi will move forward only after proper consultation process. His comments follow the recent measures by the market watchdog that have led to a decline of over 30 per cent in the volumes in the F&O segment in their initial phase of implementation.
The official said that the market regulator will take up the suggestions recommended by the expert committee on derivative markets set up under the chairmanship of G Pandmanabhan, the former executive director of RBI to its Secondary Market Advisory Committee.
While the earlier measures were to curb frenzy in the index derivatives, the new measures under discussions will be around managing risks in single stock futures and options and ensuring that a particular stock enters ban period only when it meets these new risk metrics.
Future Equivalent Metric for risk management
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The new measures are to ensure that there is correlation between the cash market and the derivative market. A lopsided market where the volume of one dominates over the volumes of the other by a very large margin can create conditions which could lead to manipulation or unnecessary volatility.
“There should not be a tail that's wagging the dog. Either the cash tail wagging the derivative dog or the derivative tail wagging the cash dog. They should both be somewhat comparable in terms of market impact,” said Narayan.
At present, open interest is measured by adding notional open interest in futures and notional open interest in options.
“Adding open interest in notional terms across futures and options is a classical example of adding apples and oranges. The two are not additive. They are not equivalent. Option has multiple risks. Delta is the immediate risk that comes out from an option. It's called the future equivalent as well—that is additive with a future position. You have to add the delta of an option with the notional of a future. So this future equivalent is a metric that makes far more sense. This is a transition that we are exploring,” explained Narayan.
At present, excessive trading of out-of-the money strike options can create large open interest in options which can hit the market wide position limit, creating a ban period in a stock. The Sebi official said that such situations can create spurious ban periods where the underlying risk is not very large and still the stock is pushed into a ban period.
Delta refers to the change in option’s price when the price of the underlying security changes in the cash market.
Moving to a delta-based metric would ensure the correctness in measuring risk, the whole-time member said.
Further, Sebi is considering linking market-wide position limits to delivery volumes under which as the volumes in the cash market go up, the limit also goes up on a dynamic basis.
Sebi may also review how exposure in derivatives is measured in mutual funds.
The consultation paper on the delta metrics or the future equivalent metrics may be floated in the first week of February.
The whole-time member cleared that the regulator is not contemplating any changes on who can trade in the derivatives market or other such suitability or appropriateness.