The long-awaited prescription for F&O addicts came up on 1st October 2024 from the Market Regulation lab of SEBI. The market regulator has stipulated six-point remedy program for Rs. 2 lakh Crore loss to retail investor in F&O segment. Prima facie, the remedies sound good. We can classify these remedies into three segments: measures to curb heightened activity in index options on expiry day, suitability of index derivative products for investors and maintenance of risk mechanism. We will discuss these remedies in a series of articles.
Remedy No. 1: Collection of upfront commission from Option Buyer: The buyer of an option is required to pay the option premium. Take an example. Nifty 26000 CE of 10th October 2024 expiry is available at a price of Rs. 107 on 1st October 2024. If you wish to buy one lot (25 quantity) of Nifty 26000 CE of 10th October 2024 expiry, you will have to pay 25*107 = Rs. 2675. This is the total premium paid to buy one lot of aforesaid Nifty Strike price. I and you have been paying this price to the broker (trading member) whenever we bought options. What is the relevance of SEBI’s diktat when it asks to collect upfront premium?
SEBI has said that brokers should collect premium upfront from the option buyer. The brokers were practicing two things: 1. collecting total premium from investors and forwarding just initial margin and extreme loss margin to the exchange/clearing corporation and 2. exploiting the rule of initial margin and extreme loss margin to provide leverage to high net worth clients. Leverage implies more brokerage and interest income on leveraged amount. The retail investors are hardly aware that out of total upfront premium of Rs. 2675, only a portion was being forwarded to the exchange as per exchange rule (Clause 14.3 of Chapter 5 of SEBI Master Circular for Stock Exchanges and Clearing Corporations dated October 16, 2023). In changed scenario, they will have to collect total premium upfront from all the option buyers and Clearing Corporation will check this collection mechanism at least four times during the trading session.
Why did SEBI prescribe this? Upfront collection of total option premium will control leveraged position and prove a deterrent for option buyers. One would say that maximum loss for an option buyer is the total premium itself, then why this rule? The brokers, sometimes, permit option buying against collaterals in greed of more brokerage. This practice will come to an end. Only those brokers would be able to continue the practice of allowing option buying against collaterals, who have tie up with NBFCs. Most of the brokers have their own NBFCs. They can arrange loan against collateral for clients and continue with the existing facility. Still, the collection of upfront premium will be effective in controlling excessive leveraged volume in option buying segment and reduce risk of default.
This measure will be implemented from 1st February 2025.
