Options Investigations: SEBI Looks At 'Exploding Volatility' And 'Killing Volatility' Trades

There is an increased focus on the index options trades undertaken on 'at the money' strikes on expiry day. The market regulator is looking at what are called 'Exploding Volatility' and 'Killing Volatility' trades on expiry day.

Simply put, it has been witnessed that on expiry day, option premiums either jump unexpectedly, which is called "exploding volatility" trades, or fall unexpectedly, which is commonly called "killing volatility" trades.

These trades normally are seen on expiry day or important events and are normally used by traders to make profit when the options expire at the end of the expiry.

As part of the option trading, traders buy options when there is low 'implied volatility,' thereby pushing up the option premium (exploding volatility). This is normally done in long trades.

Traders sell options. When there is high 'implied volatility,' the betting options premium will move towards zero (killing volatility).

While rising or falling premium trends are normal with changes in implied volatility, it needs to be investigated whether it is being done to ensure options positions are profitable at the end of expiry.

The market is witnessing volatility in premiums on the at-the-money strikes, and this is under the lens of the regulator, which is looking to see whether there is any unfair trade practice linked to this kind of trade. The regulator is yet to arrive at any conclusion on this phenomenon, which has been witnessed frequently in the last 18-24 months.

'At the money' strike is the closest strike to the current index or stock price and has the most liquidity and witnesses high trading interest by hedgers and speculators.

The option trade investigation will look at the most active brokers and investors and their counterbalancing positions on expiry day trade.

Most of the options trading happens on the index options, and this phenomenon was repeatedly seen when every day of the week there was an index expiry. Trades into Nifty 50, FINNIFTY, and Sensex will be examined. The market regulator is already investigating BANKNIFTY trades as part of the Jane Street investigation.

The market regulator has restricted weekly expiry to just one benchmark index per stock exchange since October last year. Sources with the regulator have said that the regulator is in favour of long-dated options instead of short-duration options, which lure retail and increase speculation and volatility in the market.

As part of the regulations to reduce retail participation, the stock exchanges have increased their lot sizes and margins. While it has reduced retail participants by 20%, the premium turnover continues to be high. Exchanges have also imposed delta trading limits that bring down overall position and check positions of traders intraday and at the end of the day.