**Executive Summary:**
This circular, issued by SEBI on March 24, 2022, permits recognized stock exchanges with a commodity derivatives segment to introduce options on commodity indices. It outlines the product design and risk management framework that exchanges must adhere to. Stock exchanges must obtain prior SEBI approval and amend their byelaws to implement the provisions of this circular, effective from the date of issuance.
**Key Points / Main Content:**
* **Introduction of Options on Commodity Indices:**
* Recognized Stock Exchanges with a Commodity Derivative segment can introduce options on commodity indices with prior SEBI approval.
* **Product Design and Risk Management Framework:**
* Must conform to guidelines in the circular's Annexure.
* Underlying indices must comply with SEBI Circular No. SEBI/HO/CDMRD/DNPMP/CIR/2019/71 dated June 18, 2019.
* Option contracts can be introduced on indices where futures contracts are available.
* Settlement is cash-settled upon exercise, using European style options.
* Each expiry must have at least three strikes (ITM, OTM, ATM).
* Contract size must be at least INR 5 lakh at introduction.
* ITM options are automatically exercised unless contrary instructions are given.
* Trading hours align with underlying index futures, expiring at 5:00 PM on expiry day.
* Expiry date flexibility, but cannot coincide with the rollover period of underlying constituents.
* Maximum contract tenor is 12 months initially.
* Final Settlement Price based on Volume Weighted Average Price of constituents between 4:00 PM and 5:00 PM on expiry day.
* **Position Limits:**
* Client level: Higher of 10% of total market open interest or 2000 lots.
* Trading Member level: Higher of 30% of total market open interest or 20000 lots.
* Options and futures position limits are separate.
* **Risk Management:**
* Clearing Corporations (CCs) must adhere to CPMI-IOSCO Principles.
* Risk-based margining models covering potential future exposure, using conservative estimates for close-out time horizons.
* Initial margin covers at least 99% VaR; MPOR at least two days.
* Short option minimum margin, calendar spread charge, extreme loss margin, concentration margins, additional margins, and pre-expiry margin are required.
* Initial margins imposed at the individual client portfolio level.
* Real-time computation of margin scenarios, updated at least every two hours.
* Mark to market options positions, with gains/losses not settled in cash.
* **Data and Disclosures:**
* Submit at least three years of index data (volatility, rollover yield, monthly return) to SEBI and publish on website.
* Disclose open interest of top 10 participants/groups and their combined open interest in underlying constituents, as per SEBI Circular No. SEBI/HO/CDMRD/DNPMP/CIR/2019/08.
* **Monitoring and Implementation:**
* Stock exchanges must have adequate monitoring and surveillance capacity.
* Amendments to byelaws, rules, and regulations are required.
**Impact Analysis:**
**Stock Exchanges with Commodity Derivatives Segment:**
* *Impact:* Can introduce options on commodity indices, subject to SEBI approval, increased product offerings.
* *Action Required:* Seek prior approval from SEBI, amend byelaws, disseminate circular provisions to members, and communicate implementation status to SEBI.
**Stock Brokers/Members of Stock Exchanges:**
* *Impact:* New product offerings available for trading, potential changes in trading strategies, and risk management requirements.
* *Action Required:* Familiarize themselves with the provisions of the circular and any amendments to exchange rules, adapt trading and risk management strategies accordingly.
**Clearing Corporations:**
* *Impact:* Required to implement and maintain a risk management framework compliant with CPMI-IOSCO principles, manage margins for the new options products.
* *Action Required:* Update margining models and risk management procedures to comply with the circular's requirements.
**Investors:**
* *Impact:* Access to new investment products in the commodity derivatives market, potential for diversification and hedging.
* *Action Required:* Understand the risks and features of options on commodity indices before trading.
Key Entities Referenced
Securities and Exchange Board of India (SEBI): The regulatory body for securities and commodity markets in India, responsible for approving and overseeing the introduction of options on commodity indices.
Commodity Derivatives Market: The market segment dealing with financial instruments based on commodities. The circular aims to introduce more products, specifically options on commodity indices, in this market.
Commodity Derivatives Advisory Committee (CDAC): A committee that advises SEBI on matters related to commodity derivatives. The introduction of options on commodity indices is based on the recommendation of this committee.
Stock Exchanges: Recognized stock exchanges in India having a Commodity Derivative segment, which are permitted to introduce options on commodity indices subject to SEBI approval.
Clearing Corporations (CCs): Entities responsible for clearing and settling transactions in the commodity derivatives market. They must adopt a risk management framework compliant with CPMI-IOSCO principles.
Options on Commodity Indices: The new financial product being introduced, allowing investors to trade options contracts based on commodity indices.
Securities and Exchange Board of India Act, 1992: The legislation that grants SEBI the power to protect investors' interests and regulate the securities market. This circular is issued under Section 11(1) of this Act.
CPMI-IOSCO Principles for Financial Market Infrastructures: An international standard for the design, operation, and oversight of financial market infrastructures, including clearing corporations. The risk management framework of clearing corporations should comply with these principles.
CIRCULAR
SEBI/HO/CDMRD/DNP/CIR/P/2022/34 March 24, 2022
To
The Managing Directors / Chief Executive Officers
All Recognized Stock Exchanges and Clearing Corporations having Commodity
Derivatives Segment
Dear Sir/Madam,
Sub: Introduction of Options on Commodity Indices – Product Design and Risk
Management Framework
1. In an endeavour to have more products in the Commodity Derivatives Market and
based on the recommendation of Commodity Derivatives Advisory Committee
(CDAC) and proposal from Stock Exchanges, it has now been decided to permit
recognised Stock Exchanges having a Commodity Derivative segment, to
introduce options on commodity indices.
2. The product design and risk management framework should be in conformity with
the guidelines prescribed in the Annexure to this circular.
3. The recognised Stock Exchanges with a Commodity Derivative segment, willing
to introduce trading in options on commodity indices shall take prior approval of
SEBI for the same.
4. Stock Exchanges shall submit at-least past three-years data of the index
constructed along with data on monthly volatility, roll over yield for the month and
monthly return while seeking approval from SEBI. On approval, the Stock
Exchange(s) shall also publish the above data on their website before launch of
the contract.
5. Stock Exchanges shall make necessary disclosures, such as, open interest of top
10 largest participants/group of participants in “option in indices” (both long and
short) and the details of their combined open interest in underlying constituents,
Page 1 of 6etc., in line with SEBI Circular No. SEBI/HO/CDMRD/DNPMP/CIR/P/2019/08
dated January 04, 2019 regarding “Disclosures by Stock Exchanges for
commodity derivatives”.
6. Stock exchanges shall put in place adequate monitoring and surveillance capacity
for the options on indices contracts.
7. The provisions of this circular shall be effective from date of this circular.
8. The Stock Exchanges with Commodity Derivatives segment are directed to:
8.1 take steps to make necessary amendments to the relevant bye-laws, rules
and regulations for the implementation of the same,
8.2 bring the provisions of this circular to the notice of the stock brokers/members
of the stock exchange and also to disseminate the same on their website; and
8.3 communicate to SEBI, the status of the implementation of the provisions of
this circular
9. This Circular is issued in exercise of powers conferred under Section 11 (1) of the
Securities and Exchange Board of India Act, 1992, to protect the interests of
investors in securities and to promote the development of, and to regulate the
securities market.
10. This Office Circular is issued with approval of the competent authority.
11. This circular is available on SEBI website www.sebi.gov.in under the category
“Circulars” and “Info for Commodity Derivatives Market Regulation Department”.
Yours faithfully,
Sandeep Kriplani
General Manager
Division of New Products
Commodity Derivatives Market Regulation Department
Tel. No: +91 22 26449265
Email: sandeepk@sebi.gov.in
Page 2 of 6Annexure
Product Design and Risk Management Framework for Options on Commodity
Indices
1. Underlying: The underlying shall be commodity indices, which shall conform to
the guidelines as prescribed in the SEBI Circular No. SEBI/HO/CDMRD/DNPMP/
CIR/P/2019/71 dated June 18, 2019.
2. Eligibility Criteria for Underlying: Option contracts can be introduced on those
indices on which futures contracts are available.
3. Settlement Mechanism: On exercise, options contract shall be settled in cash.
4. Exercise Style: European style options.
5. Minimum Strikes: Each option expiry shall have minimum three strikes available
viz., one each for In the Money (ITM), Out of the Money (OTM) and At the Money
(ATM).
6. Size of the Contract: At least INR 5 lakh at the time of introduction in the market.
7. Exercise Mechanism: On expiry, following mechanism shall be adopted by stock
exchanges for exercise of the options contracts:
7.1. All In the money (ITM) option contracts shall be exercised automatically, unless
‘contrary instruction’ has been given by long position holders of such contracts
for not doing so.
7.2. All Out of the money (OTM) option contracts shall expire worthless.
7.3. All exercised contracts within an option series shall be assigned to short
positions in that series in a fair and non-preferential manner.
Page 3 of 68. Trading Hours: The trading hours will be in line with the trading hours for
constituent futures of underlying index. In case trading hours vary for constituents,
trading hours for index derivatives shall be kept such that it is available for trading
whenever any of the constituent futures contract is available for trading. However,
on the day of its expiry, Index options contract shall expire at 5:00 pm.
9. Expiry Date: The stock exchanges shall have the flexibility to set the expiry date
for contracts. However, the expiry date shall not coincide with the roll-over period
of the constituents of the underlying index.
10. Tenor of the Contract: To begin with, maximum tenor of contracts shall be 12
months.
11. Final Settlement Price: The Final Settlement Price shall be the underlying index
price arrived at based on Volume Weightage Average Price of the constituents of
the underlying index between 4:00 pm and 5:00 pm on the expiry day of the Index
options contract. {In absence of trading in any constituent during last one hour,
stock exchange shall determine appropriate methodology (in line with the
methodology for determining daily closing price) to arrive at appropriate price of
the constituent to be used for determining index price}.
12. Position Limits:
12.1. Client level- Higher of:
10% of the total open interest in the market in commodity index options
Or
2000 lots
12.2. Trading Member level- Higher of:
30% of the total open interest in the market in commodity index options
Or
20000 lots
The computation of position limits for ‘options’ shall remain separate from
position limits of futures contracts on the same underlying.
Page 4 of 613. Risk Management: Clearing Corporations (CCs) shall adopt risk management
framework compliant with the CPMI-IOSCO Principles for Financial Market
Infrastructures, including the following:
13.1. Margining model and quantum of initial margins: CCs shall adopt initial
margin models and parameters that are risk-based and generate margin
requirements sufficient to cover potential future exposure to
participants/clients in the interval between the last margin collection and the
close out of positions following a participant/client default. The model should
13.1.1. use a conservative estimate of the time horizons for close out of the
positions (including in stressed market conditions),
13.1.2. have an appropriate method for measuring credit exposure that
accounts for relevant risk factors and portfolio effects, and
13.1.3. to the extent practicable and prudent, limit the need for
destabilizing, pro-cyclical changes.
Initial margin requirement shall be adequate to cover at least 99% VaR
(Value at Risk). Margin Period of Risk (MPOR) shall be at least two days. In
case of portfolio based margining, this requirement applies to each
distribution of portfolio’s exposure. Accordingly, CCs shall fix prudent price
scan range, volatility scan range and/or plausible changes in any other
parameters impacting options price. CCs shall impose appropriate short
option minimum margin, calendar spread charge, extreme loss margin,
concentration margins, additional margins, pre-expiry margin, etc. for option
contracts.
13.2. Margining at client level: CCs shall impose initial margins at the level of
portfolio of individual client.
Page 5 of 613.3. Real time computation: Though the margining models may update various
scenarios of parameter changes (underlying price, volatility etc.) at discrete
time points each day (at least every two hours), the latest available scenarios
shall be applied to client portfolios on a real time basis.
13.4. Mark to Market: CCs shall mark to market the options positions by adding
the current market value of options (positive for long options and negative for
short options) to the margin requirement. Thus, mark to market gains and
losses would not be settled in cash for options positions.
------------
Page 6 of 6