Market regulator Securities and Exchange Board of India (SEBI) is considering a comprehensive overhaul of the equity derivatives margin framework to encourage market participants to use longer-tenured index derivatives for hedging while discouraging excessive speculative activity around contract expiries, according to sources.
SEBI is considering realigning margins in the derivatives market by making capital requirements more efficient for risk-defined strategies while retaining stricter safeguards against speculative trading. These considerations are at a preliminary stage.
Incentive for longer tenor Index Derivatives
As per sources, one of the key proposals is to extend the regular margin framework for index derivatives from contracts with a residual maturity of up to 9 months to 13 months. At present, contracts with more than 9 months to expiry fall under the long-dated category and attract a separate margin framework. SEBI is considering increasing this threshold to 13 months. According to the sources, the rationale is to enable market participants to enter into index derivative contracts up to a year to hedge their risks, without higher margins.
The proposal is part of SEBI's broader attempt to encourage longer-term hedging in the derivatives market while simultaneously discouraging excessive expiry-day speculation. The regulator wants to make margins more efficient for risk-defined portfolios, curb excessive speculation on expiry days and encourage trading in long-dated index option contracts. Market participants had raised the issue of efficient margins, along with liquidity and a market-making framework, for the success of long-term equity derivatives.
A source said, " The purpose of the review is to ensure efficient margins for risk-defined portfolios, including calendar spreads and incentivise trades in long-dated index option contracts".
Increase in scenarios for SPAN-based risk model
To support the revised framework, SEBI has proposed that clearing corporations increase the number of scenarios under the SPAN-based risk model from 16 to 44. Sources added that the current framework evaluates losses across a limited number of price and volatility scenarios, making it likely that the maximum loss for some portfolios may be missed completely. Increasing the number of scenarios will improve risk measurement while allowing a recalibration of the Extreme Loss Margin (ELM) for hedged portfolios.
Low margin for risk-defined portfolio
SEBI is also considering linking the ELM to one-tenth of the Price Scan Range (PSR), subject to prescribed caps. Sources said the regulator thinks a more granular SPAN model would allow lower ELM requirements for risk-defined portfolios while maintaining broadly unchanged overall margin levels for positions carrying unlimited risk.
The scenarios have been studied, which suggest that margin requirements for certain hedged index option strategies can decline by close to 50 per cent, while calendar spreads could see margin reductions of about 30 per cent. Margin requirements for outright directional positions such as long futures and short calls, however, remain broadly unchanged. Similar reductions were observed for stock derivatives, particularly for low-volatility stocks. In contrast, margin requirements for outright long futures and naked short option positions remain broadly unchanged.
Higher ELM to continue on Expiry Days
To discourage excessive trading around contract expiry, SEBI is likely to maintain higher margin requirements on expiry days. While ELM on non-expiry days would become dynamic by linking it to the Price scan range, expiry-day margins would continue to remain elevated to deter speculative trading concentrated on settlement days
Tweak in Calendar Spread Charge
Sources said the regulator is also considering revising the Calendar Spread Charge (CSC) for index derivatives. The existing flat charge of 1.75 percent would be replaced with a graded structure based on the gap between contract expiries. Spreads with up to a three-month gap would attract a lower charge of 1.25 percent, while wider maturity gaps would attract progressively higher charges of up to 3.5 per cent, reflecting increasing basis risk.
For stock derivatives, SEBI may retain the existing calendar spread charge but introduce a more dynamic ELM framework linked to the price scan range, subject to minimum and maximum limits. It has also proposed rationalising margins for illiquid derivative stocks by linking minimum ELM requirements to impact cost in the cash market.
Higher ELM for Conversion and Reversal strategy
Another proposal seeks to impose an additional 3 percent ELM on large conversion and reversal strategies exceeding Rs 500 crore in index derivatives and Rs 100 crore in stock derivatives. SEBI's analysis suggests that such strategies were largely undertaken by foreign portfolio investors, proprietary trading firms and some clients, while mutual funds were not using them.
The regulator may also standardise the methodology for computing ELM by determining applicable ELM rates based on beginning-of-the-day parameters and using the underlying price from the latest SPAN generation exercise for both futures and options. The move is intended to reduce computational overhead while ensuring consistency in margin calculations.
The regulator has also proposed tightening the Risk Reduction Mode framework by requiring margin sufficiency checks even for orders that reduce positions, preventing traders from removing hedge positions without maintaining adequate collateral.
Another source, aware of the discussions, said, " The broader idea is to make the existing margin model in the derivative segment more efficient and to encourage the traders towards risk defined
behavior".
An email sent to SEBI for comments did not elicit any response.