On May 24, 2024, the Securities and Exchange Board of India (SEBI) issued a circular (SEBI/HO/MRD/TPD-1/P/CIR/2024/58) to all stock exchanges (except commodity derivatives exchanges) outlining enhancements to the dynamic price bands for scrips in the derivatives segment. These changes aim to better manage market volatility, mitigate risks associated with sudden price movements, and minimize information asymmetry. This article provides a detailed analysis of the circular, the modifications introduced, and their implications for market participants.
Current Mechanism and Its Shortcomings
Dynamic price bands, also known as operating ranges, are used by stock exchanges for scrips in the derivatives segment to control price volatility. The current system, as per the SEBI Master Circular dated October 16, 2023, sets the start-of-the-day price band at 10% of the previous day’s closing price. This band can be adjusted by 5% increments throughout the trading day, provided specific conditions are met, including a minimum number of trades and unique client codes (UCCs) participating on both sides of the trade.
Key Enhancements in the Circular
1. Enhanced Conditions for Flexing Price Bands
The conditions for flexing the price bands have been made more stringent to prevent sudden and erratic price movements. The number of trades required to trigger a flex has been increased from 25 to 50, the number of unique UCCs from 5 to 10, and the number of trading members on each side from none specified to 3. These changes aim to ensure that only significant and broad-based market movements can alter the price bands.
2. Alignment Between Underlying and Futures Contracts
Previously, if the price band was flexed for a scrip in the cash market, the futures contracts’ bands would also be flexed. The new rule mandates that once conditions for flexing are met in either the cash market or current month futures contracts, the price bands for the scrip and all its futures contracts across all exchanges will be flexed simultaneously after the cooling-off period. This alignment is intended to maintain consistency and reduce discrepancies between related trading instruments.
3. Adjusted Cooling Off Period and Flexing Percentage
The cooling-off period, initially set at 15 minutes, will now vary based on the number of flexes that occur. The first two flexes maintain a 15-minute period, the next two increase to 30 minutes, and any subsequent flexes extend to 60 minutes. Additionally, the percentage increment for flexing will decrease from 5% to 3% and eventually to 2% as more flexes occur. This gradual adjustment is designed to provide market participants with more time to react to news and reduce the risk of extreme price volatility.
4. Sliding Price Bands
A new sliding mechanism has been introduced, where both the upper and lower price bands move in response to flexing in one direction. For instance, if the upper band is flexed due to upward price movement, the lower band will also shift upwards, and vice versa. This approach limits the dynamic price band as the scrip price trends in one direction, thereby containing volatility more effectively.
5. Temporary Price Ceilings/Floors in Options Trading
During the cooling-off period, temporary price floors or ceilings will be imposed on options contracts based on the prevailing price trends of the underlying scrip. These temporary limits are intended to stabilize the options market during periods of high volatility in the underlying scrip, allowing traders to manage their positions until the price bands are flexed.
Implementation Timeline and Responsibilities
The circular outlines a phased implementation schedule:
- Enhancements to conditions for flexing price bands (Para A) will be effective from June 3, 2024.
- Alignment of price bands between underlying and futures contracts (Para B) and adjustments to cooling off periods and flexing percentages (Para C) will be effective from August 19, 2024.
- The sliding price band mechanism (Para D) and temporary price ceilings/floors in options trading (Para E) will be effective from October 21, 2024.
Stock exchanges are required to develop comprehensive Standard Operating Procedures (SOPs), update their infrastructure and systems, and communicate these changes to market participants.
Conclusion
SEBI’s enhancements to the dynamic price bands for derivatives aim to strengthen market stability and protect investors. By increasing the thresholds for flexing price bands, aligning price bands across markets, adjusting cooling off periods and flexing percentages, and introducing sliding price bands and temporary limits in options trading, SEBI seeks to manage volatility more effectively and ensure orderly market behavior. These changes reflect SEBI’s commitment to improving market infrastructure and safeguarding investor interests in a rapidly evolving financial landscape.
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Securities and Exchange Board of India
Circular No. SEBI/HO/MRD/TPD-1/P/CIR/2024/58 Dated: May 24, 2024
To
All Stock Exchanges
(Except Commodity Derivatives Exchanges)
Sir/Madam,
Enhancement of Dynamic Price Bands for scrips in the Derivatives segment
1. For scrips excluded from the requirement of price bands, a mechanism of dynamic price bands (or operating range) has been implemented by Stock Exchanges. The present formulation for dynamic price band for underlying in cash market and derivatives contracts on them as per Clause 2.5 of Chapter 1 and Clause 1.10.3 of Chapter 4 of SEBI Master circular dated October 16, 2023 for Stock Exchanges and Clearing Corporations and existing practice, is summarized below:
a. Underlying in cash market and futures contracts have start of the day price band as 10% of yesterday’s closing price of that scrip/contract as a dynamic price band.
b. These price bands can be flexed by 5% of yesterday’s closing price during the day as many times as required subject to the following conditions followed by the cooling off period
c. In the event market trends in either direction, the conditions precedent for flexing is minimum of 25 trades to be executed with minimum 5 different UCCs on each side of the trade at or above 9.90% and so on. That is to say if 25 trades from 5 different UCCs on each side occurred at or above 9.90%, the dynamic price band is flexed to 15%, if 25 trades from 5 different UCCs on each side occurred at or above 14.90%, the dynamic price band is again flexed to 20% etc.
d. Cooling Off: After the aforesaid conditions are satisfied, a cooling off period of 15 minutes is provided before the price band is flexed. It may be noted that during the cooling off period, trading continues in the underlying scrip / futures contracts albeit with the prevalent price floor/ceiling as applicable.
e. The options contracts continue to trade in their applicable price bands when underlying cools off after hitting the price band.
f. If price band in cash market is flexed for a scrip, then the price band for
the futures contracts is also flexed.
g. Whenever price band of a scrip or futures contracts is flexed in one direction (i.e. in the direction of price trend), the price band on the other side remains unchanged.
2. Principles behind construct of dynamic price band, existing formulation and the need for enhancement were summarized by SEBI in its consultation paper dated May 20, 2023 titled Price Band formulation for scrips in Equity Derivatives segment to strengthen volatility management and minimise information asymmetry. On the basis of feedback received from various stakeholders, discussions held with Secondary Market Advisory Committee of SEBI and Stock Exchanges, the modified framework for price band formulation for scrips in the derivatives segment is provided below.
(A) Enhancing conditions precedent before flexing price band
3. To take care of issues related to sudden price movement / fat finger error etc., the conditions precedents, as mentioned at Para 1(c) of this Circular, are enhanced to 50 trades, 10 unique UCCs and 3 trading members on each side.
(B) Aligning price bands between underlying and its futures contracts
4. In modification of the requirement mentioned at Para 1(f) of this circular, exchanges shall ensure that when conditions for flexing the price bands are satisfied on either underlying in cash market or current month futures contracts on any exchange, the price band would be flexed for the scrip and all the futures contracts on this scrip across all exchanges at the end of subsequent cooling off period.
(C) Strengthening Volatility/Risk Management and minimizing information asymmetry for extreme price movement
5. As scrip price keeps trending in one direction, it is required to provide adequate time to market participants to assimilate any company / market specific news flow thereby resulting in orderly price movement while reducing strain on settlement systems on account of extreme price movements in one direction. Accordingly, in modification of the requirement mentioned at Para 1(b) and 1(d) of this circular, it has been decided that the cooling off period of 15 minutes would be increased and the flexing percent of 5% would be decreased, in a calibrated manner, as follows:
a. For the first two instances of flexing, the price band would be flexed by 5% of yesterday’s closing price after the cooling off period. This cooling off period would be 15 minutes if conditions for flexing are satisfied before last half an hour of trading and 5 minutes if conditions for flexing are satisfied in the last half an hour of trading.
b. For subsequent two instances of flexing, price band would be flexed by 3% of yesterday’s closing price after the cooling off period of 30 minutes.
c. For subsequent instances of flexing, price band would be flexed by 2% of yesterday’s closing price after the cooling off period of 60 minutes.
(D) Sliding price band on account of flexing
6. In modification of the practice mentioned at Para 1(g) of this circular, whenever price band of a scrip or futures contracts is flexed in one direction, the price band on the other side would be flexed concurrently by equivalent amount in the direction of price movement. Orders pending in the erstwhile price band and the new price band, after sliding, would be cancelled by exchanges. This would limit the dynamic price band as scrip price trends in one direction and in effect limit the price volatility. This would also provide an opportunity to market participants to place their orders nearer to the prevailing market price.
7. For instance, yesterday’s closing price was Rs. 100 and today’s lower band and upper band were Rs. 90 and Rs. 110 respectively. If price trends upwards, resulting in upper price band being flexed to Rs. 115 (after satisfying enhanced conditions precedent), the lower band would shift upwards to Rs. 95 and orders lying between Rs. 90 to Rs. 95 would be cancelled by exchange. It may be noted that if the price subsequently trends downwards on the same day and hits the new lower band i.e. Rs. 95, the same would be flexed downwards to Rs. 90 after satisfying the aforesaid enhanced conditions.
8. Stock Exchanges would put in place necessary mechanism to intimate trading members/clients regarding such cancelled orders.
(E) Trading in options segment during cooling off in underlying / futures contracts
9. In modification of the practice mentioned at Para 1(e) of this circular, a temporary price floor or ceiling for options in the sentimental direction of price trend in the underlying, as applicable, would be placed in the options, once underlying scrip triggers cooling off. This is summarised below:
a. If the Last Traded Price (LTP) of the options contract is available and not stale, the temporary floor or ceiling as applicable, would be linked to LTP of options contract.
b. If the LTP of the options contract is unavailable or stale, the temporary floor or ceiling as applicable, would be linked to theoretical price of the options contract.
c. Such temporary floor or ceiling would allow certain absolute rupee movement or percentage movement over the last traded price/ theoretical price to allow market participants to, for instance, hedge/close their open positions by executing trades in options during cooling off.
d. Once price band for underlying scrip is flexed, at the end of cooling off period, the price band for options contracts would be flexed concurrently, thereby doing away with temporary floor or ceiling.
e. Stock Exchanges would put in place uniform formulation around the above requirements.
10. The Stock Exchanges are directed to:
a. Prepare a comprehensive Standard Operating Procedure, within 45 days from the date of the circular, to implement various operational issues emanating from the circular and suitably intimate market participants regarding the same in due course;
b. Take necessary steps to put in place requisite infrastructure and systems for implementation of the circular, including necessary amendments to the relevant bye-laws, rules and regulations;
c. Bring the provisions of this circular to the notice of their members and also disseminate the same on their website; and
d. Communicate to SEBI, the status of implementation of the provisions of this circular as per the stipulated timelines.
11. The circular would be implemented by Stock Exchanges in a phased manner. Requirements mentioned at Para (A) of the circular would be effective from June 03, 2024, those at Para (B) and (C) would be effective from August 19, 2024 and those at Para (D) and (E) would be effective from October 21, 2024 onwards.
12. The circular is being 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.
Yours faithfully,
Ansuman Dev Pradhan
Deputy General Manager
Technology, Process Re-engineering, Data Analytics
Market Regulation Department
+91-22-26449622
Email: [email protected]
