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TMI BlogRisk containment measures for Stock OptionX X X X Extracts X X X X X X X X Extracts X X X X ..... al Group' headed by Prof. J.R Varma to prescribe risk containment measures for new derivative products. The group has recommended the introduction of Exchange traded Options on Stocks, which is also in conformity with the sequence of introduction of derivative products recommended by Dr. L.C Gupta Committee. The 'Technical Group' has recommended the risk containment measure for Exchange traded Options on Stocks. While SEBI would not mandate any particular risk management product, the framework shall be consistent with the risk management guidelines mandated by the L. C. Gupta Committee. The Exchanges are free to decide whether they want to adopt any of the risk management models available globally or else may like to develop their own mode ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... olio of each individual client comprising of his positions in Derivative Contracts. The parameters for such a model should include the following A. Worst Scenario Loss The worst case loss of a portfolio would be calculated by valuing the portfolio under several scenarios (as specified in SEBI Circular No. IES/DC/CIR-5/00 dated December 11, 2000) of changes in the Stock prices and changes in the volatility of the Stock. The price range for generating the scenarios for Stock Option Contracts would be three and a half standard deviation (3.5 Sigma). The sigma value would be calculated using the methodology specified for Index Futures as per the Prof. J.R Varma Committee Report. The volatility range for generating scenarios for Stock Option ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h for stock option positions also. D. Cash Settlement of Premium For the Stock Option positions, the premium shall be paid in by the buyers in cash and paid out to the sellers in cash on T+1 day. E. Exercise & Assignment The Exchanges are free to set exercise limits, if any, for the Stock Option Contracts. The assignment of all exercise shall be done randomly at the client level by the Exchange and its Clearing House. F. Unpaid Premium Until the buyer pays in the premium, the premium due shall be deducted from the available Liquid Net Worth on a real time basis. G. Exposure Limit The notional value of gross open positions at any point in time for Index Futures and all Short Index Option Contracts shall not exceed 33 1/3 (thirty ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the market wide limit in that contract, the exchanges would double the price range and volatility range as specified in Point No. (A) in this circular. The exchanges are required to continously review the impact of this measure and take further proactive risk containment measures as may be appropriate, including, further increases in the scan ranges and levying additional margins. The cash market segment of the Exchange should be informed of these developments so as to enable the cash segment also to take such risk containment and surveillance measures as may be appropriate. I. The computation of Worst Scenario Loss has two components. The first is the valuation of each option contract under sixteen scenarios using an appropriate option ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sensex or S&P CNX Nifty) should not be more than 4, at any time during the previous six months. For this purpose the volatility would be computed as per the Exponentially Weighted Moving Average formula specified in the Prof. J. R Varma Committee Report on the risk containment measures for Index Futures. It is further clarified that the stock on which option contracts are permitted to be traded on one derivative Exchange/Segment would also be permitted to trade on other Derivative Exchanges/Segments. The volatility estimates calculated as mentioned in Point No.(v) above shall be calculated on the last one and a half year closing price data in the following manner: * The standard deviation of logarithmic return (natural log) would be cal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... giving details of the calculations mentioned above and ensuring that the stock fulfills the eligibility criterion specified. iii. Lot Size / Multiplier iv. Strike Price Intervals v. Premium Quotation vi. Last Trading Day vii. Expiration day/month viii. Exercise Style ix. Mode of Assignment x. Time period of settlement of Option Exercise xi. Position and Exercise Limits xii. Margin xiii. Trading Hours b. the economic purpose it is intended to serve, c. likely contribution to market development, d. the safeguards and the risk protection mechanism adopted by the exchange to ensure market integrity, protection of investors and smooth and orderly trading, e. the infrastructure of the exchange and the surveillance system ..... X X X X Extracts X X X X X X X X Extracts X X X X
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