SEBI Signals Massive Margin Overhaul: Traders Get Relief for Long-Term Hedging as Expiry Speculation Faces Higher Costs

SEBI Signals Massive Margin Overhaul: Traders Get Relief for Long-Term Hedging as Expiry Speculation Faces Higher Costs​

Market regulator Securities and Exchange Board of India (SEBI) is initiating a comprehensive review of the equity derivatives margin framework. The move aims to streamline capital requirements, making them more efficient for risk-defined strategies while simultaneously erecting stronger safeguards against excessive speculation concentrated around contract expiries. These considerations are at a preliminary stage, signaling a major structural shift in how derivative positions will be managed and priced.

Boosting Long-Term Hedging with Extended Derivatives​

A key proposal from SEBI aims to significantly incentivize market participants toward long-term hedging strategies. The regulator is considering extending the standard margin framework for index derivatives, increasing the allowable residual maturity period from contracts with up to 9 months to 13 months. Currently, contracts exceeding nine months are categorized separately under a specialized long-dated margin framework.

This proposed change intends to allow market users to enter into index derivative contracts lasting up to a year without facing heightened collateral demands. SEBI’s goal is twofold: making margins efficient for genuinely risk-defined portfolios and curbing speculative trading on short expiry days. This move responds directly to feedback from the market concerning the need for more streamlined margins, liquidity, and effective market-making structures in long-term equity derivatives.

Rethinking Risk Modeling and Margin Relief Potential​

To support a more refined framework, SEBI has proposed an increase in scenarios used within the SPAN-based risk model by clearing corporations. The current requirement is set at 16 scenarios, with the proposal aiming for this number to rise to 44. Sources noted that the existing limited scenario evaluations may cause some maximum losses for specific portfolios to be missed entirely.

Increasing the complexity of the scenarios will enhance risk measurement and allow for a recalibration of the Extreme Loss Margin (ELM) specifically designed for hedged positions. SEBI is also examining linking the ELM to one-tenth of the Price Scan Range (PSR), subject to prescribed caps. This granular SPAN model could translate into substantial margin reductions for certain strategies.

Substantial Margin Reductions and Targeted Regulation​

Preliminary studies suggest that these framework changes could yield significant savings in collateral requirements across some segments. Specifically, margin requirements for certain hedged index option strategies could decline by close to 50 percent. Calendar spreads are also set to see potential margin reductions of around 30 percent.

In contrast, the margins for outright directional positions such as long futures and short calls remain broadly unchanged under the proposals. Similar reductions were observed for stock derivatives in particular for low-volatility stocks. However, margin requirements for naked short option positions and outright long futures will continue to be broadly consistent with current levels.

Deterring Speculation While Introducing New Charges​

SEBI is likely to maintain higher margin requirements specifically on expiry days to effectively discourage excessive speculative activity concentrated around settlement dates. This contrasts sharply with the potential dynamic reduction of ELM on non-expiry days, which would link ELM to the Price Scan Range.

The regulator is also mulling a revision of the Calendar Spread Charge (CSC) for index derivatives. The existing flat charge of 1.75 percent will be replaced by a graded structure based on the gap between contract expiries. Spreads featuring up to a three-month gap would face a lower charge of 1.25 percent, while wider maturity gaps could incur charges rising progressively up to 3.5 per cent to reflect increasing basis risk.

New Rules for Large Conversion and Reversal Strategies​

Furthermore, SEBI may introduce an additional 3 percent ELM requirement targeting large conversion and reversal strategies in derivatives. These strategies must exceed Rs 500 crore in index derivatives or Rs 100 crore in stock derivatives. The analysis behind this proposal indicated that these specific strategies were primarily undertaken by foreign portfolio investors and proprietary trading firms, rather than mutual funds.

The regulator is also proposing to standardize the ELM computation methodology across the board. This involves defining applicable ELM rates based on beginning-of-the-day parameters and utilizing the underlying price from the latest SPAN generation exercise for both futures and options. Additionally, a tighter Risk Reduction Mode framework will be introduced, requiring margin sufficiency checks even for orders that seek to reduce existing positions.