Previously in this column, we discussed SEBI’s proposal to determine market wide position limit based on futures equivalent open interest (FEqOI). This measure is scheduled to take effect from October 1, 2025. SEBI has also proposed a cap on index option positions. A trader cannot have more than 1,500 (10,000) crore end-of-the-day net (gross) exposure. This measure, linked to FEqOI, takes effect on July 1, 2025. This week, we discuss the likely impact of this cap on trading.

OTM demand

Delta captures the approximate change in a derivatives’ price for a one-point change in the underlying. Futures has a delta of one. An at-the-money (ATM) call option has a delta of 0.50. This indicates that a Nifty ATM option is likely to move up 0.50 point per one-point increase in the Nifty Index. If you buy ten contracts of the ATM strike for a positional trade, then you will add five contracts on a FEqOI basis. 

There could be more demand for farther out-of-the-money (OTM) strikes after the FEqOI takes effect. Why? As such, demand for in-the-money (ITM) strikes is low because of European-style settlement; you can exercise the option only at expiry. But holding the option till expiry is fraught with issues. For one, you will lose time value with each passing day. For another, the underlying could reverse and wipe out unrealised gains on your option position. For these reasons, you ought to sell your options before expiry. But that would require a counterparty to buy the option at the last traded price. Typically, ITM options are not preferred because it fully prices the intrinsic value. That increases the absolute price of the option, leading to larger trading capital. 

Combine the low demand for ITM strikes with the FEqOI measure and you are likely to see a demand shift to more OTM strikes. If traders are less inclined to hold ITM strikes, you must close your long position when a strike moves from ATM to ITM. But that would also mean capturing lower gains, especially from spread strategies such as bull call spread, and bear put spread. Note that as a retail trader, you may still be able to sell ITM strikes but at lower implied volatilities. Why? Lower demand for a strike will lead to lower option price. This means lower time value for the option, translating into lower implied volatility, a component of time value. 

Quick tip
A trader cannot have more than 1,500 (10,000) crore end-of-the-day net (gross) exposure. This measure, linked to FEqOI, takes effect on July 1, 2025.

Optional Reading

Retail traders typically prefer options because of lower trading capital. But futures offer better gains for a given change in underlying price. Traders must be mindful of choosing futures and options based on comparable reward-to-risk ratio, not how much their intended position adds to the FEqOI. A possible shift in demand to more OTM strikes could also create newer opportunities for volatility arbitrage trades, going long on an ITM strike with lower implied volatility and short on same-expiry delta-neutral quantity of OTM strike with higher implied volatility.

(The author offers training programmes for individuals to manage their personal investments)

Published on June 28, 2025