Regulatory Risk Containment Measures on Single Stock Derivatives

Significant additional risk containment measures such as the revision of market-wide position limits, increasing the margin requirements for both equity cash and derivatives, and flexing of price bands were imposed by the Securities and Exchange Board of India in the Indian securities markets in March 2020. The objective was to curtail volatility, ensure orderly trading, improve risk management and price discovery, and help maintain market integrity. This study concentrates on assessing the ban on trading in single stock derivatives arising from the downward revision of MWPLs on liquidity and volatility. Liquidity measures used for the study are the Amihud illiquidity ratio and turnover ratio, and volatility is measured using the Yang–Zhang and Rogers, Satchell, and Yoon models. The result of the study shows that the imposition of the ban results in the reduction of volatility and liquidity during the ban period across the sample set of stocks.

Financial instruments serve the twin purpose of investment and hedging to maximise wealth and manage risks, respectively. Instruments like equity, bonds, and mutual fund units are designed to serve the purpose of wealth creation. Derivatives are primarily for managing risks. Based on the general structure and covenant, equities are riskier as compared to bonds. Similarly, a derivative instrument can be used for hedging or speculation (profit motive) based on user preferences. Thus, all financial instruments not only provide returns but also carry significant risks. Financial consumers seek ways to minimise the risks associated with the financial instruments and maximise the return through portfolio diversification (Markowitz 1952) and by using derivatives.