Risk containment measures for Option on Indices

IES/DC/CIR-5/00 · 2000-12-11 · SEBI Investigations Enforcement & Surveillance Department

Summary

This SEBI circular establishes risk containment measures for the introduction of exchange-traded options on indices, following recommendations by a Technical Group. It mandates that exchanges obtain prior approval for contracts and initially introduce premium-style European options settled in cash. The document details specific margining requirements, including worst-case loss calculations, calendar spread margins, and position limits to ensure market integrity.

Text

SEBI has setup a ‘ Technical Group’ headed by Prof. J.R Varma to prescribe risk containment measures for new derivative products. The group has recommended the introduction of Exchange traded Options on Indices which is also in conformity with the sequence of introduction of derivative products recommended by Dr. L.C Gupta Committee.

While SEBI would not mandate any particular risk management product, the framework shall be consistent with the risk management guidelines mandated by the L. C. Gupta Committee. The Exchanges are free to decide whether they want to adopt any of the risk management models available globally or else may like to develop their own models for risk management.

The Index option contracts to be traded on the derivative exchange/segments shall have prior approval of SEBI. The Contract should comply with the disclosure requirements, if any, laid down by SEBI.

Initially, the Exchanges shall introduce premium style index options.

Initially the Exchanges shall introduce European style Index Options which shall be settled in cash. The risk containment measures described hereunder are only for premium style European option contracts.

The Index Option Contract shall have a minimum contract size of Rs. 2 lakhs at the time of its introduction in the market.

The Index Option contract shall have maximum maturity of 12 months and shall have a minimum of 3 strikes (in the money, near the money and out of the money)

The Initial Margin requirements shall be based on worst case loss of a portfolio of an individual client to cover a 99% VaR over a one day horizon. The Initial Margin requirement shall be netted at level of individual client and it shall be on gross basis at the level of Trading / Clearing Member. The Initial margin requirement for the proprietary position of Trading/Clearing member shall also be on net basis.

The worst case loss of a portfolio would be calculated by valuing the portfolio under several scenarios of changes in the index and changes in the volatility of the index. The price range is defined to be three standard deviations as calculated for VaR purposes in the index futures market for the near month contract. The volatility range would be taken at 4% for an initial period of six months, after which it shall be reviewed.

For the purpose of the calculation of option values the exchanges may use any of the following standard Option Pricing Models – Black-Scholes, Binomial, Merton, Adesi-Whaley.

The margin for calendar spread would be the same as specified for the index futures contracts. However, the margin shall be calculated on the basis of delta of the portfolio in each month. A calendar spread would be treated as a naked position in the far month contract three trading days before the near month contract expires.

The Short Option Minimum Margin equal to 3% of the Notional Value of all short index options shall be charged if sum of the Worst Scenario Loss and the Calendar Spread Margin is lower than the Short Option Minimum Margin.

Source: SecMarx — Risk containment measures for Option on Indices. Verbatim text is public record; SecMarx structuring (linkage to applying orders) is cited to us.