Position limits

If one participant can build an enormous position in a derivative, that participant can move the market — or fail and take others down. Position limits stop that from building up.

The workbook explains: in order to avoid building up of huge open positions, the regulator has specified the maximum allowable open position limit at client level, member level etc. Position limits are the maximum exposure levels (open position) which the entire market can go up to and each trading member or investor can go up to.

Most limits are written as the higher of a percentage of open interest and a fixed rupee amount. The percentage lets big players grow as the market grows; the rupee floor stops the limit becoming uselessly small in a thin market.

Cash settled IRD (futures and options) on G-Secs:

Exchange-level cap: the overall open position on all IRD contracts on a specific underlying shall not exceed 25% of the outstanding underlying bond.

Money market futures:

Gross open position. For client-level limits, long = long futures, long calls and short puts; short = short futures, short calls and long puts.

FPI extras. Each FPI's gross short position may not exceed its long position in G-Secs and IRFs; aggregate FPI net long positions are capped at Rs 5,000 crore; no FPI may hold a net long position above Rs 1,800 crore. A breach must be squared off within 5 trading days or by contract expiry, whichever is earlier.

Monitoring. Limits apply when opening a position, based on the previous day's end-of-day open interest, and are always specified in number of lots. If OI then falls, positions need not be unwound, but the member cannot increase or create positions in that bucket until compliant. No separate limit applies at clearing member level, though the clearing member is accountable for everyone clearing through it.

The workbook's worked case. At end of day, total open interest in the 8–11 year bucket is 10 lakh contracts on Exchange A and 5 lakh contracts on Exchange B. The limits for the next day:

On Exchange B the rupee floors bite: the percentage would have given a smaller limit, so the fixed lot numbers apply.

Counting a client's position. A mutual fund scheme on Exchange B holds, in the 8–11 year bucket:

Gross long = 9,000 + 4,000 + 3,000 = 16,000 lots, within its 20,000-lot limit. It could add 4,000 more long-side lots. A short put counts toward the long side because it gains when the bond rises — which is exactly the kind of position the rule is designed not to miss.

Chapter 7 (Clearing, Settlement and Risk Management of IRD), section 7.6, sets out every position limit table — G-Sec IRD by maturity bucket, 91-day T-Bill and MIBOR futures, corporate bond index futures — plus the FPI limits, the gross open position rule and the Exchange A/B worked example. Expect a calculation of the applicable limit from open interest, a question on how long and short positions are counted, and a question on what happens when open interest falls.

• The limit is the higher of the percentage and the fixed amount, not the lower.
• Limits are always specified in number of lots, computed from the previous day's end-of-day open interest.
• Short puts count as long; long puts count as short.
• Mutual funds: AMC level is in the 10% category; scheme level is in the 3% category.
• Exchange-level cap is 25% of the outstanding underlying bond.
• FPIs: aggregate net long Rs 5,000 crore; individual net long Rs 1,800 crore; breaches squared off within 5 trading days or by expiry, whichever is earlier.
• A fall in open interest does not force immediate unwinding — but no new or larger positions in that bucket until compliant.
• There is no separate clearing member position limit, though the clearing member is accountable.