Circuit filters on derivatives stocks to add volatility: FPIs

Mumbai: Foreign portfolio investors (FPIs) have expressed concerns over the market regulator’s proposal to impose circuit filters on the stocks that trade in derivatives market. In a letter addressed to the Securities and Exchange Board of India (Sebi), leading FPI lobby Asia Securities Industry and Financial Markets Association (Asifma) said such a move could induce more volatility and distort market equilibrium. The foreign fund lobby body suggested that Sebi should undertake more comprehensiv ..

The market regulator had floated a discussion paper in January proposing introduction of circuit filters for scrips that are traded in the derivatives market. In the discussion paper, Sebi had talked about two different proposals: one to put in place hard circuit filters which would be triggered if any scrip moves over 20 per cent either way. The other proposal was to introduce a combination of dynamic and fixed price bands or a call auction mechanism.

Asfima said the first proposal would be disadvantageous for option buyers whose premium is decided by the market volatility and the duration of the contract. “Enforcing fixed limits may result in a manufactured loss for option buyers as the underlying price moves become restricted after certain point. It is unclear what the unintended consequences might be as market equilibrium becomes distorted,” said Asifma in the letter. Also, having such hard limits could make many derivative positions out o ..

On the second proposal of introducing combination of dynamic and fixed price bands or call auctions, Asifma said it could create challenges on timely re-computation of the indices. “Given the current dominance in the market by retail investors, such a complexity may cause more damage to retail investors first than to other market participants,” Asifma said.

Retail investors contribute approximately 25 per cent to the country’s total equity derivatives volumes.

Alternatively, the FPI lobby has suggested Sebi to introduce circuit breakers to derivatives in the similar lines as the cash market. Such a framework would stop any sudden fall in the prices and curtail unnatural volatility in the market.

Currently, stock exchanges have circuit breakers in place for indices in the cash market. For instance, if the Nifty surges or falls 10 per cent in a session, fresh trading in the index is halted for 15-45 minutes. While, the trading will be halted for 105 minutes if the index moves 15 per cent in a session. Any movement above 20 per cent would lead to shut-down of trading in the index for the rest of the session.

The market regulator had proposed these curbs on the derivatives market t ..