Derivatives at the Edge: Evaluating SEBI’s Formalization of Expiry Structures

[Kartikey Narang is a second year law student at Hidayatullah National Law University, Raipur]

Introduction

Expiry days in equity derivatives markets have long been associated with a surge in trading activity, heightened volatility, and potential risks to market integrity. Known commonly as "expiry-day hyperactivity," this phenomenon has led regulators worldwide to consider structural and operational interventions. SEBI's Consultation Paper (2025) proposes formalizing expiry days to Tuesday or Thursday to provide predictability, reduce concentration risk, and manage systemic threats. This paper interrogates whether such a measure aligns with SEBI's mandate under the SEBI Act, 1992, and whether it balances market stability with innovation and hedging efficiency. It further considers whether expiry-day reforms might be a minimal solution to a much broader issue surrounding market speculation and retail overexposure.

Understanding Expiry-Day Hyperactivity: Market and Legal Perspectives

Expiry-day hyperactivity refers to the spike in volumes and volatility witnessed on the day a derivative contract expires. Traders rush to square off or roll over positions, often leading to price distortions, illiquidity at specific price points, and temporary misalignments between spot and futures prices. The exponential growth of options trading in India has magnified this issue, with weekly options on indices like Nifty and Bank Nifty contributing significantly to volume spikes and unusual order flows.

Under Section 11 of the SEBI Act, 1992, SEBI is empowered to protect investors and regulate the securities market. Clause 1.1.10 of Chapter 5 of the SEBI Master Circular (2024) empowers exchanges to fix expiry dates while ensuring that market integrity and contract specifications remain unaffected. Further, the Securities Contracts (Regulation) Act, 1956 (SCRA), under Section 2(ac), recognizes derivatives as securities, bringing them within SEBI’s regulatory ambit. SEBI's Circular and the Consultation Paper (2025) build on these provisions to propose a uniform structure for expiry days, seeking to balance innovation with market safety. The proposal underscores the regulator’s commitment to ensuring that the framework remains conducive to orderly development while safeguarding against speculative excesses.

The current practice allows multiple exchanges to choose varying expiry days, often leading to clustering and arbitrage-driven speculation. By limiting expiry to only Tuesday or Thursday, the new proposal aims to:

●      Spread out trading activity more evenly across the week

●      Prevent last-minute strategic shifts by exchanges to gain volume share

●      Diminish opportunities for manipulative expiry-specific strategies

SEBI cites the rise in volumes and volatility on expiry days as a systemic risk. Volatility spillovers can affect underlying cash markets, influence investor sentiment, and even trigger algorithmic errors. This is particularly pertinent given the growing number of retail investors entering the derivatives market, many of whom may lack a nuanced understanding of the risks involved. By enforcing fixed expiry days, SEBI seeks to introduce a layer of temporal discipline to curb such destabilizing behavior. Legitimate hedgers such as institutional investors, mutual funds, and pension funds require certainty. By formalizing expiry days, SEBI seeks to provide a structured environment conducive to informed risk management while also streamlining operational planning for custodians and clearing corporations.

The power to regulate trading practices stems from Section 11(2)(a) of the SEBI Act, which allows SEBI to "regulate the business in stock exchanges.

"The current proposal falls well within this framework. However, concerns may arise around potential overreach if such regulation leads to unintended centralization or inhibits technological and contractual innovation. In SEBI v. Rakhi Trading Pvt Ltd, the Supreme Court upheld SEBI's proactive market surveillance powers, especially in detecting and curbing manipulation. The Court affirmed that "regulatory intervention is warranted even in the absence of proven intent when the conduct is damaging to market integrity."

Similarly, in MCX Stock Exchange Ltd. v. SEBI, the Bombay High Court underscored SEBI’s discretion to impose structural reforms in the interest of safeguarding market efficiency. These precedents provide strong judicial validation of SEBI's proposal to standardize expiry days. A critical concern is whether this proposal limits the autonomy of exchanges to offer differentiated products. While SEBI has clarified that exchanges may choose either Tuesday or Thursday for their index expiries, the new requirement for prior approval could create procedural delays. Moreover, this move might reduce the competitive differentiation that underpins product innovation in derivatives markets.

Behavioral Analysis and Market Impact

India’s derivatives market has seen a surge in retail participation, especially post-pandemic. Behavioral finance suggests that predictable expiry days may foster herd behavior, particularly among retail traders following simplistic cues such as price trends and market sentiment. This raises concerns about the unintended concentration of risk among uninformed participants.

Expiry days are known to attract High-Frequency Trading and algorithmic strategies aimed at exploiting price inefficiencies. By reducing expiry options to two days, such strategies may concentrate further, possibly leading to flash crashes or liquidity gaps during high-volume intervals. SEBI must, therefore, complement expiry formalization with measures such as order-to-trade ratio limits, dynamic price bands, and stress-testing algorithms. There’s also a need to study how expiry-day reforms affect the cash market. For instance, significant price movements in futures can lead to arbitrage opportunities that distort spot prices. This could adversely affect long-term investors and mutual funds whose Net Assets Value may be impacted by expiry-day price swings.

Critique and Recommendations

While the proposed measure seeks market stability, it may inadvertently constrain product innovation. A more calibrated approach would involve creating a sandbox mechanism where exchanges can experiment with alternative expiry days under SEBI’s supervision. SEBI should publish data-driven analyses on how expiry formalization impacts trading behavior. Pre- and post-policy comparative studies, involving volatility indices, roll-over patterns, and settlement efficiency metrics, would offer valuable feedback loops.

Expiry-day volatility is a symptom, not the disease. A stronger approach may involve improving surveillance, penalizing manipulative trades, and using AI/ML tools to predict volatility spikes. This should include tracking social media sentiment and retail order clustering. Rather than mandating expiry days, SEBI could approve a set of acceptable days and allow exchanges to choose within that framework under defined criteria. This would promote healthy competition while ensuring systemic safeguards. To meaningfully reduce speculative excess, SEBI must invest in investor education. Retail traders often misinterpret the payoff structure of options or engage in leveraged trades without adequate understanding. SEBI, in collaboration with exchanges and educational institutions, should develop structured programs explaining derivative risks and expiry-day dynamics. Introducing a risk-tiered margining system, where novice traders face higher margins or restricted access to certain contracts, could mitigate speculative build-up near expiry. A graded framework aligned with a trader's experience level and trading history would discourage risky behavior without impacting professionals. SEBI and exchanges should release regular data on expiry-day volatility, option gamma exposure, and roll-over statistics. Public dissemination would increase transparency and empower institutions and analysts to track structural changes.

Given the rapidly evolving market structure, any reform must be subject to periodic review. SEBI should institutionalize a Derivatives Review Board comprising experts from academia, law, trading, and risk management to advise on dynamic adjustments based on market data and trends. Deploying real-time anomaly detection tools, utilizing machine learning can help identify suspicious patterns leading to expiry-day spikes. Exchanges should integrate these tools into their trade surveillance engines, coupled with instant alerts to compliance teams. India can benefit from cross-border regulatory dialogue on expiry practices and volatility mitigation. A coordinated effort through IOSCO or bilateral cooperation with major jurisdictions can help align expiry norms with global best practices, easing participation by global investors.

Conclusion

SEBI’s proposal to mitigate expiry-day hyperactivity through formalization is a welcome step toward market stability. It is grounded in sound legal authority and aligns with global practices. However, it must be implemented with broader reforms targeting surveillance, margin discipline, and empirical data transparency. The path to safer derivatives markets lies not in rigidity but in responsive, adaptive regulation that accommodates innovation while safeguarding investor interests. SEBI must continue to engage with stakeholders, monitor outcomes, and recalibrate policy as required in the dynamic context of India’s financial markets.