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Explained: SEBI curbs on short selling through F&O, fresh margins on cash market trades

Explained: SEBI curbs on short selling through F&O, fresh margins on cash market trades

Explained: SEBI curbs on short selling through F&O, fresh margins on cash market trades
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By Santosh Nair  Mar 21, 2020 10:44:42 AM IST (Updated)

What are the various announcements that SEBI has announced and will they be effective?

Note to readers: This copy has been updated with additional information about the curbs on short and long positions in index derivatives

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Market regulator SEBI on Friday announced limits on the positions that traders can take in the futures and options segment.
Also, SEBI introduced margins in the cash market on stocks part of the F&O list and even on stocks not part of the list.
In addition, the regulator has specified conditions under which institutional investors—local and foreign—and individual traders can bet on index futures.
Here's an FAQ explaining the move.
  • Why did SEBI announce these measures?
  • This has been done to curb short selling, both in the F&O segment as well as in the cash market. Short selling is a market practice in which an individual trader or fund manager sells a stock, in the hope of buying it back at a lower price.
    • Are short sellers to blame for the present stock market crash?
    • No. The crash has more to do with fundamental factors. But yes, short-selling can aggravate the slide in stock prices. That is the reason why regulators tend to clamp down on short-sellers when there is panic in the market.
      • Take me through each of the measures. SEBI has reduced the marketwide position limit (MWPL) in F&O stocks to 50 percent of current levels. To begin with, what is MWPL?
      • MWPL is the maximum position that can be taken in the derivatives segment, both futures and options contracts combined. This number is linked to the trading volume in the cash market or free-float (non-promoter shares) in the company. At present, MWPL is the lower of 30 times average number of shares traded daily in the cash segment, during the previous month, or 20 percent of the shares held by non-promoters. This means that if the public shareholding in a company totals 100 shares, then the positions that can be taken up through futures and options contracts should not exceed 20 shares.
        • What is the new limit now?
        • If the public shareholding in a company totals 100 shares, the positions that can be taken up through futures and options contracts should not exceed 10 shares.
          • What happens if the limit is breached?
          • When outstanding positions in an F&O stock cross 95 percent of MWPL, the security goes into a “ban period”. In the ban period, no fresh long or short positions can be taken. Traders, who have existing long and short positions will be allowed to reduce their positions by squaring-off.
            • What if a trader still takes up a fresh position in a security in the ban period?
            • He will be penalized by the stock exchange.
              • Is the new limit applicable for every security on the F&O list?
              • No. It is applicable for F&O securities which are volatile or see unusually high trading activity. So the new limit will be applicable to those stocks where the variation between the high and low price of the day is equal to or more than 15 percent, for 5 days in a row. The new limit will also be applicable for securities where the average MWPL utilization percentage during last 5 trading days is equal to or more than 40 percent.
                • What about penalties for breach of this rule?
                • SEBI has recommended that the penalties be 10 times of the minimum and 5 times of the maximum penalties specified by the stock exchanges and clearing corporations.
                  • Why is there an MWPL in place?
                  • In the absence of an MWPL, traders would use the derivatives route to influence the price of the stock. In the real world, the spot price sets the basis for the derivatives price. Without an MWPL, it could well become a case of the tail wagging the dog.
                    • What about margins in the cash market?
                    • For stocks part of the F&O list, the cash market margin will be increased to minimum 40 percent in a phased manner from March 23.
                      - Minimum 20 percent from March 23
                      - Minimum 30 percent from March 26
                      - Minimum 40 percent effective from March 30.
                      • What about F&O margins in these securities?
                      • They remained unchanged.
                        • What about margins in the cash market for stocks not part of the F&O list?
                        • The stock exchanges will be focusing on the stocks that are volatile.
                          For stocks with an intra-day circuit filter of 20 percent and witnessing an intraday (high-low) price movement of more than 10 percent for 3 or more days in the last 1 month, minimum margin rate shall be increased in a phased manner as follows:
                          - 30 percent to be effective from March 23, 2020
                          - 40 percent to be effective from March 26, 2020
                          • How long will the margins be in effect for?
                          • The SEBI said that the margin “may be” applicable for a month. Note the use the of the word “may.” So the margins could stay for lesser time or even a longer time, depending on market conditions.
                            • What purpose will the margins serve?
                            • This will ensure that only the serious players remain in the game. Buy only if you have the money and sell only if you have the shares. This reduces the probability of buyers defaulting on their commitments and deters the non-serious sellers going short on a stock.
                              • What about curbs on trades in index futures?
                              • Upto Rs 500 crore notional value of index futures, there are no restrictions. Beyond Rs 500 crore, mutual funds, foreign institutions and individual traders can take short positions in index derivatives only to the extent of the value of the shares owned by them. In other words, they can only hedge their portfolio by short selling index futures. After the initial limit of Rs 500 crore is exhausted, and a player owns Rs 100 crore of shares, he can only have an additional short position of Rs 100 crore in index derivatives. He cannot have an additional short position of Rs 200 crore just because he is confident that the market will go down.
                                This is to restrict "naked short sales" or short selling without the backing of any securities. Investors will anyway sell their shares if they have a bearish view on the market. But curbs on naked short selling makes it difficult for traders to hammer down prices with ease.
                                • What about curbs on the long side of index futures?
                                • Here too, there are no restrictions for the first Rs 500 crore notional value of long positions in index futures. Beyond that, mutual funds, foreign institutions and individual traders can take long positions in index derivatives only to the extent of their holdings of cash, government securities, T-Bills and similar instruments, for positions  This is to ensure that institutions are in a position to honour their trades should the prices move against them.
                                  • Will these measures help stabilize the market?
                                  • In the short term, maybe yes. But the stability will come at a cost. Because of the trading curbs, many players will be unable to participate. That will make the market illiquid. In all fairness, speculative activity helps better price discovery. When the market lacks depth, prices will become more volatile.
                                     
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