All equity derivatives in India are traded on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). The system used by NSE is known as NEAT (National Exchange Automated Trading). Orders in this system are matched electronically based on price–time priority, which means the best-priced orders get executed first, and if prices are the same, the one that was placed earlier gets priority. This ensures a transparent and fair trading environment with no manual intervention.
Key Features:
Anonymous Trading: The identity of the buyer and seller is not revealed to each other. The Clearing Corporation (NSCCL) acts as the central counterparty to every trade, guaranteeing settlement and eliminating counterparty risk.
Order-Driven Market: The market is driven by buy and sell orders. It's not a quote-driven market where market makers provide bid/ask quotes.
Settlement: The settlement cycle is T+1 for cash market and marked-to-market daily for derivatives.
6.2 Market Participants
The main entities involved in the Indian derivatives market are:
Trading Members (Brokers): These are firms registered with SEBI and the exchanges. They provide access to the trading system for clients. They can be individuals, partnerships, or corporate bodies.
Clients (Investors/Traders): These can be retail investors, high-net-worth individuals (HNIs), or institutional clients like mutual funds and Foreign Institutional Investors (FIIs).
Clearing Members: They are responsible for settling the trades of their own clients or other trading members. There are three types:
Self-Clearing Member (SCM): Clears and settles trades for their own account and their own clients.
Trading-Cum-Clearing Member (TCM): Trades on their own account and clears trades for other trading members.
Professional Clearing Member (PCM): Clears and settles trades for a fee for other trading members and clients, without engaging in trading themselves.
Clearing Corporation (NSCCL): This is the most crucial entity. It acts as the legal counterparty to every trade and guarantees the financial settlement, taking on all counterparty risk. It's a subsidiary of NSE.
6.3 Margins in Derivatives Trading
Margins are collected to ensure that market participants can meet their obligations and prevent defaults. They are a form of performance guarantee.
Initial Margin (SPAN): This is the first margin collected from both the buyer and seller of futures and the seller of options. It is calculated using the SPAN (Standard Portfolio Analysis of Risk) system and is a Value-at-Risk (VaR) based margin that covers the potential worst-case loss of a portfolio over a one-day period.
Exposure Margin: This is an additional margin collected over and above the initial margin. It acts as a cushion for sudden, large market movements that may not be fully covered by the VaR-based SPAN margin.
Mark-to-Market (MTM) Margin: This is a daily settlement of the profit or loss on all outstanding futures positions. It is paid in cash at the end of each trading day. If a member's MTM loss exceeds their initial margin, they must deposit additional funds.
Premium Margin (Options): For an option buyer, the premium they pay for the option itself serves as their only margin, as their maximum loss is limited to the premium paid. Option sellers, however, must deposit initial, exposure, and MTM margins.
6.4 Position Limits & Ban Period
To prevent market manipulation and excessive speculation, SEBI sets position limits at various levels:
Client Level Limits: An individual client's open interest in a single contract cannot exceed a certain percentage of the market-wide position limit.
Trading Member Limits: The total open interest of a trading member (across all their clients) is also capped.
Market-Wide Position Limits (MWPL): This is the maximum open interest allowed for a particular stock. It is based on a percentage of the stock's free-float market capitalization.
FII/DII Limits: Foreign and Domestic Institutional Investors also have specific position limits.
Ban Period: A stock's F&O segment goes into a ban period when its open interest crosses 95% of the MWPL. During this period, no new positions can be created, but existing positions can be closed. The ban is lifted only when the open interest falls below 80% of the MWPL.
6.5 Contract Specifications & Settlement
All derivatives contracts have standardized specifications:
Lot Size: The minimum number of units that can be traded in a single contract, fixed by the exchange (e.g., Nifty 50 lot = 50 units).
Expiry: The last trading day of a contract. For all monthly futures and options contracts, it's the last Thursday of the contract month. If it's a holiday, expiry shifts to the previous working day.
Series Available: Three consecutive monthly contracts are available for trading (e.g., Near, Mid, Far month).
Settlement Types:
Index Derivatives: Index futures and options are cash settled. The final settlement is based on the difference between the final settlement price (closing price of the underlying index on the expiry day) and the contract price.
Stock Derivatives: Stock futures and options are physically settled on expiry day. This means if a contract is In-The-Money (ITM), the seller must deliver the actual shares to the buyer, and the buyer must receive them.
6.6 Risk Management & Surveillance
The exchanges have a robust risk management system to protect market integrity and investor interest. Key components include:
Circuit Filters & Dynamic Price Bands: While index derivatives don't have traditional price bands, dynamic price bands are applied to control intra-day volatility. If a price moves outside a defined range, trading is briefly halted to re-evaluate.
Margins: As discussed, margins are the primary tool for mitigating credit risk.
Position Limits: Limits at client, member, and market-wide levels prevent concentration risk.
Surveillance: SEBI and the exchanges have advanced surveillance systems to monitor trading activity and detect potential market manipulation or insider trading.
The IRRA platform is an alternate path for investors to close out their outstanding positions in case of a system outage at the trading member's end. It's a crucial tool for investor protection, allowing them to manage their risk when their primary trading access is unavailable.