NCFM Derivatives Market (Dealers) Module: Chapter 7 Short Notes (Part 3 of 3)

Chapter 7: Trading of Derivatives Contracts — Scrip & Index Eligibility, Corporate Actions, and Transaction Charges

7.4 Criteria for Stocks and Index Eligibility for Derivative Trading

To ensure market integrity, protect investors from cornering, and guarantee adequate liquidity, the Securities and Exchange Board of India (SEBI) and the National Stock Exchange of India (NSE) enforce rigorous eligibility benchmarks for individual stocks and stock indices entering or continuing in the F&O segment.

7.4.1 Eligibility Criteria for Individual Equity Stocks

A stock must fulfill three cumulative quantitative filters based on six-month rolling historical trading data to become eligible for derivative contract introduction:

1. Top-Tier Ranking: The stock must rank among the top 500 equities in terms of average daily market capitalisation and average daily traded value during the previous six months on a rolling basis.
2. Order Size & Market Impact (Quarter-Sigma Criterion): The stock's median quarter-sigma order size over the previous six months must not be less than Rs. 5 lakhs.
   • Definition: Quarter-sigma order size represents the order value required to cause a change in the stock price equal to 0.25 (one-quarter) of a standard deviation.
3. Market-Wide Position Limit (MWPL): The Market-Wide Position Limit in the stock must not be less than Rs. 100 crores.
   • Computation: MWPL is defined as 20% of the number of non-promoter (free-float) shares held in the underlying security, valued at the closing cash market price on the contract expiry date.

Continued Eligibility & Exit Framework for Existing Stocks

The exchange applies continuous performance monitoring to ensure active stocks maintain liquidity:

Note: All fresh contract introductions on eligible securities require explicit prior approval from SEBI.

7.4.2 Eligibility Criteria for Stock Indices

To qualify for index futures and index options trading, a composite stock index must satisfy strict constituent eligibility rules:

• 80% Coverage Rule: Component stocks contributing to at least 80% of the weightage of the candidate index must individually meet the stock eligibility criteria for derivative trading.
• 5% Single Ineligible Stock Cap: No single ineligible stock included in the index can carry a weightage exceeding 5% of the total index value.
• Monthly Surveillance & Exclusion: Eligibility criteria are reviewed every month. If an index fails compliance for three consecutive months, no fresh contract months are issued, though existing unexpired series trade until maturity.

7.4.3 Eligibility Criteria Post Corporate Restructuring

When a company listed in the F&O segment undergoes corporate restructuring (e.g., mergers, demergers, spin-offs, or hive-offs), reintroduction of derivative contracts on the post-restructured entity from its first day of cash market listing requires meeting four mandatory conditions:

1. Pre-Restructuring F&O Status: Derivative contracts on the original pre-restructured company were actively traded on an exchange prior to restructuring.
2. Pre-Restructuring Size Floor: The original pre-restructured company maintained a market capitalisation of at least Rs. 1000 crores prior to restructuring.
3. Relative Scale Benchmark: The post-restructured company is evaluated as a new scrip and is expected to be at least one-third (1/3rd) the size of the pre-restructure company in terms of revenues, total assets, or analyst valuations.
4. Free-Float Integrity: The restructuring scheme must not generate structural flaws, such as an extremely low free float, that would render the stock vulnerable to market manipulation.

Exchange Action Plan Upon Listing:

• Listing Month Contract Rollout: The exchange introduces near-month, middle-month, and far-month derivative contracts on the post-restructured stock on the first day of listing.
• Subsequent Months: Standard rolling inclusion/exclusion tests apply. If normal criteria are not satisfied in subsequent evaluations, further contract series are discontinued.

7.5 Charges, Brokerage, and Statutory Levies

Trading on the F&O segment incurs exchange transaction charges, broker fees, and statutory contributions governed by exchange regulations and SEBI rules.

7.5.1 Maximum Permissible Brokerage Limits

• Regulatory Ceiling: The maximum brokerage fee chargeable by a Trading Member (TM) to clients for derivative contract execution is capped at 2.5% of the total contract value (excluding statutory levies).
• Client Disclosure: TMs are mandated to issue standard contract notes detailing brokerage and levies without charging excess fees.

7.5.2 Exchange Transaction Charge Structure for Futures

NSE periodically reviews transaction fees levied on trading members. The slab structure for stock and index futures based on monthly cumulative traded value is detailed below:

7.5.3 Options Sub-Segment Transaction Charges & Brokerage Norms

• Premium-Based Calculation: Transaction charges for options are levied strictly on the traded option premium value rather than on the strike price value.
• Standard Exchange Rate: Charged at a flat rate of 0.05% (each side) on the total premium value.
• Brokerage Mandate for Clients: Trading members are instructed to charge client brokerage based on the traded premium price rather than the underlying strike price.

7.5.4 Investor Protection Fund (IPF) Contribution

To maintain investor compensation reserves for the derivative segment, trading members contribute to the Investor Protection Fund at a rate of Re. 1 per Rs. 100 crores of traded value (each side).

Key Terms & Important Concepts

• Quarter-Sigma Order Size: Order value required to cause a stock price movement equal to 0.25 of its standard deviation.
• Market-Wide Position Limit (MWPL): Maximum aggregate open positions allowed across all buyers and sellers in a stock, set at 20% of non-promoter free-float shares.
• 80% Weightage Rule: Index eligibility rule requiring 80% of index weight to consist of individually eligible F&O stocks.
• 1-Year Exclusion Period: Mandatory waiting period before a dropped stock can be re-considered for F&O entry.
• Premium-Based Charges: Levy of transaction fees and brokerage on options based on option premium rather than full strike value.
• Investor Protection Fund (IPF): Statutory pool funded at Re. 1 per Rs. 100 crores traded value to safeguard investor interests.

Chapter 7 Complete Module Summary Takeaways

1. Fully Automated Infrastructure: NEAT-F&O operates an automated, nationwide, order-driven market matching orders by Security, Price, Time, and Quantity.
2. Hierarchy & Administrative Controls: Corporate Manager, Branch Manager, Dealer, and Admin User tiers ensure clear risk monitoring; Admin users have full monitoring access but cannot trade.
3. Four Derivative Categories: NSE trades Index Futures (FUTIDX), Index Options (OPTIDX), Stock Futures (FUTSTK), and Stock Options (OPTSTK) expiring on the last Thursday of the month.
4. Rigorous Stock Filters: New F&O stock inclusions require top 500 ranking, quarter-sigma order size >= Rs. 5 lakhs, and MWPL >= Rs. 100 crores.
5. Strict Exit & Re-entry Norms: Scrips failing continued eligibility (MWPL < Rs. 60 crores) for 3 consecutive months face contract bans and a 1-year re-inclusion cooling period.
6. Transparent Cost Structure: Maximum allowable brokerage is 2.5% of contract value; options charges apply at 0.05% of traded premium.