Market Stability vs. Overregulation: SEBI’s Take on F&O Rules
- IBS Times
- 15 minutes ago
- 5 min read
By - Hema Sri Harsha
The Futures and Options (F&O) market is an important part of financial markets, through which investors can hedge risks and speculate. Yet, with the sudden surge in retail participation, there have been fears of uninformed trading and rising investor losses.
SEBI Chairman Tuhin Kanta Pandey has cautioned against over-regulation in the advanced Futures and Options (F&O) market, and emphasized adopting a balanced approach. Addressing his speech at the Mint India Investment Summit and Awards 2025, he highlighted the risks of a "sledgehammer" approach that can destroy market efficiency and investor participation. While retail presence in derivatives trading has increased, SEBI worries about the growing losses to individual investors.

In the wake of such issues, the regulator has taken a series of measures with a view to stemming speculative trading and maintaining the stability of the market, including enhancing the minimum contract size and mandating higher margin requirements. Pandey also talked of the delayed Initial Public Offering (IPO) of the National Stock Exchange (NSE), citing delays due to regulatory issues with respect to clearing corporations. While SEBI navigates through these complexities, its intent never gets lost sight of—building a duly regulated but dynamic financial market that endows investor protection with market development.
Key Measures Taken by SEBI in the F&O Market
Increase in Minimum Contract Size:
SEBI has raised the lot size for index derivatives, i.e., investors now require a greater initial capital investment to trade F&O. The policy is intended to deter small, unsophisticated retail investors from indulging in over-the-top speculation, with only well-funded operators entering the fray. By making trading derivatives more expensive, SEBI hopes to curb irresponsible trading habits that tend to lead to large losses for individual traders.
Advance Premium Collection for Options Trading
To avoid traders entering heavily leveraged positions with insufficient funds, SEBI has made it mandatory for brokers to receive the entire premium amount in advance from option buyers. Earlier, traders used to take big positions with a minimal margin, exposing themselves to huge risks of losses. In mandating the full payment of premium, SEBI ensures that investors make prudent decisions regarding the risk to take before getting into the market, ensuring a healthier trading atmosphere.

Rationalization of Weekly Index Derivatives
SEBI is reorganization the frequency and availability of weekly index derivatives to discourage excessive short-term speculation. The launch of several weekly expiries had resulted in added volatility and pushed speculative trading strategies with high risk. Through its rationalization of the availability of such instruments, SEBI seeks to induce a more stable and predictable derivatives market with less unnecessary market volatility triggered by speculative trading.
Improved Risk Disclosure to Retail Investors
To make retail investors aware of the risk involved in F&O trading, SEBI has made brokers and exchanges carry out more detailed risk disclosures. These disclosures offer better information about possible losses and the intricacies involved in trading derivatives. This step is specifically relevant considering the increased retail participation, as numerous fresh traders might lack a complete awareness of how the derivatives market works.

Uncover Options Selling as a Focus
SEBI is mulling over tighter regulation of uncovered (naked) options selling, a risky approach in which the sellers of options do not have the underlying security or adequate margin. The method can lead to unlimited losses if the market is against the seller. Through stricter regulations, SEBI hopes to safeguard retail investors from sudden financial shocks and make participants enter F&O trading with proper risk management techniques.
Stricter Margin Requirements for Derivatives Trading
SEBI has imposed stricter margin requirements on F&O trading to make sure that traders are well-capitalized to meet losses, if any. Higher margin requirements help to avoid excessive leverage, which can increase both gains and losses. This step makes sure that market participants have adequate resources to absorb sudden price movements, minimizing the possibility of defaults and market volatility. The new rules of margin favour prudent trading behaviour and shield investors from assuming risk beyond their capability.
Impact of a "Sledgehammer" Approach on the F&O Market:
1.Lower Market Efficiency and Liquidity
If SEBI applies too-stringent rules—e.g., significantly increasing margin requirements, proscribing specific F&O products, or massively raising contract sizes—market liquidity would be jeopardized. Trading in F&O relies upon institutional investor, retail trader, and market-maker participation. When several participants walk away because regulations are too onerous, liquidity would decrease, and trading would become less efficient. More adverse liquidity levels also cause the bid-ask spread to expand, raising traders' costs for executing trades.
For instance, if SEBI increases the minimum capital required for F&O trading beyond a reasonable threshold, it could drive away many retail traders, leaving only institutional investors and high-net-worth individuals in the market. This could make price discovery inefficient and hinder the primary function of derivatives as risk-management tools.
2. Increased Trading Costs to Investors
Excessive regulation may drive F&O trading costs up for investors. Tighter margin requirements and increased initial capital requirements would cause traders to invest more to keep their positions open. While it might help limit hare-brained speculation, it could also make it hard for legitimate market participants like hedgers and institutional players to manage their risk.
For instance, a sharp increase in margin levels might deter corporate houses and institutional investors from applying F&O for hedging. Most corporations use derivatives to hedge price risks in commodities, interest rates, and currencies. If the regulatory framework is over-strict, they might shift to alternative markets or offshore bourses to undertake these transactions, eventually draining liquidity from Indian markets.
3. Retail Participation and Financial Inclusion Decline
The Indian derivatives market has seen a spurt in retail participation with numerous new entrants into the F&O segment. While the direction has spelt fear of uninformed trading and retail losses, an extreme lowering of accessibility in the form of restrictive policies could deter retail investors from participating at all.
For instance, if SEBI increases the minimum size of a contract too much, it could drive retail traders away from the derivatives segment altogether. This would focus market power with institutional investors, restricting financial inclusion by denying small traders access to hedging and investment choices.
4. Increased Market Volatility
While regulations seek to curb excessive speculation, a too restrictive policy could result in unwanted volatility. If SEBI were to suddenly impose bans or draconian restrictions on F&O trading, market players might respond negatively, causing panic selling or sudden price movements.
For example, a sudden jump in margin requirements or curtailing short-selling possibilities can compel the traders to liquidate their positions in haste, creating price distortions. Institutional investors who use derivatives to offset their portfolios can find it difficult to shift gear rapidly, increasing market instability.
5. Movement of Trading Activity to Offshore Markets
If regulations in the domestic market become too tight, institutional investors and traders might move their F&O business to foreign markets with more relaxed regulatory conditions. Exchanges in Singapore, Dubai, or the United States could entice Indian market participants with more enticing conditions.
One of the most important instances of this was when the Singapore Exchange (SGX) became popular for Nifty derivative trading, and there were fears that liquidity was shifting away from Indian exchanges. If SEBI adopts too restrictive policies, more investors will seek to trade derivatives on international platforms, and Indian exchanges such as NSE and BSE will lose market share.

A balanced regulatory strategy is needed to make India's F&O market stable and grow. While SEBI's desire to shield retail investors and check excess speculation is essential, a "sledgehammer" approach with too stringent rules can lower liquidity, raise trading costs, and push investors into offshore markets. Rather than blanket restrictions, SEBI needs to have targeted measures that encourage responsible trading without stifling market efficiency. Using gradual reforms, improving risk disclosures, and robust investor education, SEBI can establish a well-regulated but dynamic derivatives market to the advantage of both institutional and retail investors.
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