The Hindu Business Line : Derivative contract

THE Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs 2 lakh.

Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs 2 lakh at the time of introducing the contract in the market.

What is the lot size of a contract?

Lot size refers to the number of underlying securities in one contract. Additionally, for stock-specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded of to the next higher multiple of 100.

This requirement of SEBI coupled with the requirement of minimum contract size forms the basis of arriving at the lot size of a contract.

For example, if shares of XYZ Ltd are quoted at Rs 1,000 each and the minimum contract size is Rs 2 lakh, then the lot size for that particular scrips stands to be 200000/1000 = 200 shares i.e. one contract in XYZ Ltd covers 200 shares.

What is the margining system in the derivative markets?

Two type of margins have been specified:

Initial Margin is based on 99 per cent VaR and worst case loss over a specified horizon, which depends on the time in which mark-to-market margin is collected.

Mark-to-Market Margin (MTM) is collected in cash for all futures contracts and adjusted against the available liquid networth for option positions. In the case of futures contracts, MTM may be considered as mark-to-market settlement.

What are the position limits?

The position limits specified are as under-

Client/customer level position limits:

For index-based products there is a disclosure requirement for clients whose position exceeds 15 per cent of the open interest of the market in index products.

For stock specific products the gross open position across all derivative contracts on a particular underlying of a customer/client should not exceed the higher of -

One per cent of the free float market capitalisation (in terms of number of shares) or

Five per cent of the open interest in the derivative contracts on a particular underlying stock (in terms of number of contracts).

This position limits are applicable on the combine position in all derivative contracts on an underlying stock at an exchange. The exchanges are required to achieve client level position monitoring in stages.

Trading member level position limits

For index products the Trading Member position limits are Rs 100 crore or 15 per cent of the open interest whichever is higher.

For stock specific products the trading member position limit are at 7.5 per cent of the open interest or Rs 50 crore whichever is higher for derivative contract in a particular underlying at an exchange.

It is also specified that once a member reaches the position limit in a particular underlying then the member shall be permitted to take only offsetting positions (which result in lowering the open position of the member) in derivative contracts on that underlying.

In the event that the position limit is breached due to the reduction in the overall open interest in the market, the member shall be permitted to take only offsetting positions (which result in lowering the open position of the member) in derivative contract in that underlying and no fresh positions shall be permitted.

The position limit at trading member level are required to be computed on a gross basis across all clients of the trading member.

Market wide limits

There are no market wide limits for index products. However for stock specific products the market wide limit of open positions (in terms of the number of underlying stock) on an option and futures contract on a particular underlying stock would be lower of -

Thirty times the average number of shares traded daily, during the previous calendar month, in the cash segment of the exchange,

Ten per cent of the number of shares held by non-promoters i.e. 10 per cent of the free float, in terms of number of shares of a company.

It is further specified that when the total open interest in a contract reaches 80 per cent of the market wide limit in that contract, the exchanges would double the price scan range and volatility scan range specified.

The exchanges are required to continuously review the impact of this measure and take further proactive risk containment measures as may be appropriate, including, further increases in the scan ranges and levying additional margins.

Source: www.sebi.gov.in

Queries relating to futures/options may be sent to

fno@thehindu.co.in

or to Futures & Options, Kasturi & Sons, 859-860, Anna Salai, Chennai 600 002.

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