SEBI has said that it is open to revising the limit provided the request is backed by data to support it.
Large options traders, such as fund managers and brokerages with proprietary trading desks, say that the gross future equivalent or delta-based position limits being proposed by market regulator Securities and Exchange Board of India (Sebi) can help curtail possible manipulation by a single entity.
But they are divided on the cap that needs to be set. Some believe that the proposed gross limit need only be doubled, while others say it should be higher by a much bigger number. According to the latter, the proposed limit would only cover a tenth of the exposure that large prop shops currently take.
In a conversation with Moneycontrol, Sebi’s Whole-time Member Ananth Narayan had said that the regulator is open to revising the limits if the market participants approach them with relevant data.
On February 24, Sebi issued a consultation paper titled “Enhancing Trading Convenience and Strengthening Risk Monitoring in Equity Derivatives”.
It suggested a new way of measuring risk in the market. It proposed adopting delta-based open-interest (OI), and moving away from the current notional OI, to determine the risk that individual investors and the market as a whole is exposed to.
OI is the total number of active derivatives contracts in the market.
Also read: MC Explains: How SEBI may improve risk-measurement in options trading
While this has largely been welcomed by big options traders, it is another proposal in the consultation paper that has raised alarm bells. The other proposal is on setting a gross delta-OI based position limit.
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The paper proposes monitoring of intraday positions and ensuring that they stay below a net delta-OI based limit (of Rs 1,000 crore) and a gross delta-OI based limit (of Rs 2,500 crore) for options contracts of a single index.
(This is outside of the proposed futures EOD and intraday limits of Rs 1,500 crore (thrice what it is now) and Rs 2,500 crore, respectively.)
Again, the big, market-making traders are fine with the net limit set for options contracts. Where they are divided is on the gross delta OI-based limit and how much it should be increased by.
Sebi has set the limit to address risks that are not covered by a delta-anchored measure. The regulator could have set limits for all the Greeks (gamma, theta, vega and delta) individually, but they fear that may prove to be too complicated for investors, particularly smaller participants, to track.
Therefore, it has proposed the gross future-equivalent or delta OI limit as a surrogate way to capture the risks of all the residual Greeks.
While fund managers appreciate the intent behind setting this limit, they have differing views on the cap that needs to be set. While some believe that a doubling of the limit to Rs 5,000 crore will suffice, to leave enough headroom for market makers to provide liquidity and address the fears of market manipulation by a single entity, others believe that it should be raised by 3x to 4x (Rs 7,500 crore to Rs 10,000 crore).
According to them, the regulator will need to find a fine balance between keeping manipulative trading practices out and maintaining the liquidity in the market.
Striking the balance
In the recent past, fund managers have alleged that the Indian derivatives market is being manipulated by a single entity or a small group of entities, which either moves the underlying index sharply to one side to profit from their derivatives positions or keeps the underlying in a tight range — again to profit from their derivatives position. Moneycontrol has written about their concerns.
If gross limits are set as Sebi has proposed, 10 to 11 entities would need to work in tandem to do the alleged manipulation, and if the gross limits are doubled, it would require roughly seven to eight entities working together, said a hedge fund manager. This coordinated activity, according to him, would become nearly impossible to do.
A brokerage’s proprietary trader who had raised concerns about the possibility of manipulation in the market, too, said that the proposed limits will definitely put an end to such activities, but added that the proposed limit will also mean the end of a lot of prop desks (which are largely brokerages trading with their own money) that provide liquidity to the market.
“Different traders or trading houses will have a different view on how much this limit needs to be raised to, depending on the exposure they are currently taking. But, overall, the larger prop shops now currently take ten times the exposure proposed in the consulting paper. The regulator seems to asking them to shut shop,” he said.
Mayank Bansal, a leading options trader, does not think that the gross limit needs to be raised by many multiples. He thinks doubling the proposed limit to Rs 5,000 crore will be enough to stop any possible manipulation by a single entity and also keep proprietary trading houses in business.
“The limits offer a trade-off between curtailing possible manipulation and allowing (large) entities to run their business,” he said. However, the ideal way to tackle any manipulation would be “to identify and ban the manipulating entity (or entities), without setting overly tight limits in order to achieve the same,” he said.