Mutual Funds Seek Greater Participation in India's F&O Market Amid Regulatory Reforms

resr 5paisa Research Team

Last Updated: 16th May 2025 - 03:32 pm

3 min read

India's mutual fund industry is eyeing a bigger role in the rapidly growing futures and options (F&O) market. This shift is happening alongside new regulatory reforms introduced by SEBI, all aimed at keeping the market stable and protecting investors.

From Hedge Protection to Return Generation

Mutual funds have typically played it safe with derivatives, using them mainly to hedge against risks. But now, with the F&O market booming, asset managers are rethinking their strategy. They see derivatives as a shield and a potential tool to boost returns and diversify portfolios.

A significant shift happened in October 2024 when SEBI gave a new investment product the green light. It blends features of traditional mutual fund schemes with portfolio management services (PMS), giving mutual funds more flexibility. In short, they can now behave more like hedge funds, using derivatives to manage risk and chase higher returns.

A. Balasubramanian, CEO of Aditya Birla Sun Life AMC, summarises: "This change opens the door for mutual funds to enter the F&O (futures and options) space, which has mostly been the playground of retail traders and proprietary firms until now."

There's a catch, though: SEBI has capped derivatives exposure for these new mutual fund products at 25% of the fund's total assets. This limit helps ensure a balance, giving mutual funds access to higher-risk strategies while keeping things in check for everyday investors.

SEBI's Reform Plan: Growth Without the Chaos

SEBI's recent rule changes show they're trying to encourage market innovation without letting things spiral out of control. In May 2025, for instance, SEBI scrapped a plan to cap intraday options trades. Market participants warned the cap could disrupt legitimate trading activity, so instead, SEBI opted to beef up monitoring and crack down on any shady moves.

SEBI has updated how open interest is calculated for both stock and index derivatives to make things more transparent. They've also significantly raised limits on options positions: the gross limit is now ₹100 billion, and the net limit is ₹15 billion, much higher than the original proposals.

Other reforms include real-time monitoring of F&O activity, tighter exposure limits for mutual and alternative investment funds (AIFs), and updated caps on index derivatives. For example, index options are now capped at ₹500 crore (net) and ₹1,500 crore (gross) at the end of the day. For intraday trades, those limits jump to ₹1,000 crore (net) and ₹2,500 crore (gross).

A Caution Flag for Retail Traders

Retail investors are still flooding the index options market, even though the odds aren't in their favour. SEBI's own data shows that fewer than 1 in 10 retail F&O traders turn a profit, which raises some serious red flags about risk awareness and financial literacy.

In response, SEBI may examine retail activity more closely and, depending on its findings, implement more measures to protect investors.

Mutual Funds Dipping Their Toes in Derivatives

So far, mutual funds have been active in the derivatives market, mainly through stock futures. As of January 8, 2025, their open interest in stock futures was nearly ₹259,000 crore. But they've held back when it comes to index options. On that same day, there were no buy positions and just ₹304 crore in sell positions.

This cautious stance reflects how mutual funds have historically approached derivatives, as a way to hedge, not to chase high-risk gains. But that may change soon, thanks to new rules and investment tools that make it easier for them to explore this space more boldly.

Looking Ahead

The push from mutual funds to play a bigger role in the F&O market is in step with SEBI's broader strategy: grow the market, but protect the people. As mutual funds use more advanced strategies like derivatives for alpha generation, they will likely become bigger players.

But with that comes a responsibility: managing risk and ensuring investors know what they're getting into. SEBI's focus on stronger surveillance, clear position limits, and better financial education will be key.

The bottom line? Mutual funds expanding into the F&O market could offer investors exciting new opportunities. But success will depend on keeping risk under control and ensuring investors understand the game they're playing.

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