Scrip Selection Criteria

How are scrips selected for inclusion in Derivatives Segment?

The selection of securities for trading on the Futures & Options Segment is based on the following broad eligibility criteria:

1. The security should be amongst the top 500 securities in terms of average daily market capitalization and average daily traded value during the previous six months.
2. The securities median quarter sigma order size over the last six months should be at least Rs. 5 Lakhs.

What is Quarter Sigma?

Sigma means standard deviation which is used to measure volatility in any scrip or index. Quarter Sigma order size is defined as the order size (value) required to cause a change in the stock price equal to one-quarter of a standard deviation. So if the sigma of a stock is 3%, what is the order size (value) required to make a change in the stock price equal to 0.75%?

How is the Quarter Sigma calculated?

The Quarter Sigma order size is calculated by taking four order book snapshots in a day for a security for the last six months.

The detailed procedure is outlined below:

1. The applicable VAR (Value at Risk) is calculated for each security based on the J.R. Varma Committee guidelines. (The formula suggested by J. R. Varma for computation of VAR for margin calculation is statistically known as ‘Exponentially weighted moving average (EWMA)’ method. In comparison to the traditional method, EWMA has the advantage of giving more weight to the recent price movements and less weight to the historical price movements.)
2. Such computed VAR is a value (like 3%), which is also called standard deviation or Sigma. (The meaning of this figure is that the security has the probability to move 3% to the lower side or 3% to the upper side on the next trading day from the current closing price of the security).
3. Such arrived at standard deviation (one sigma), is multiplied by 0.25 to arrive at the quarter sigma.
   (For example, if one sigma is 3%, then quarter sigma is 0.75%)
4. From the order snapshots (taken four times a day from NSE’s Capital Market Segment order book) the average of best buy price and best sell price is computed which is called the average price.
5. The quarter sigma is then multiplied with the average price to arrive at quarter sigma price. The following example explains the same :

   Security	XYZ
   Best Buy (in Rs.)	306.45
   Best Sell (in Rs.)	306.90
   Average Price	306.70
   One Sigma	3%
   Quarter sigma	0.75%
   Quarter sigma price (Rs.) (Average Price *Quarter sigma)	2.30

    
6. Based on the order snapshot, the value of the order (order size in Rs.), which will move the price of the security by quarter sigma price in buy and sell side is computed. The value of such order size is called Quarter Sigma order size. (Based on the above example, it will be required to compute the value of the order (Rs.) to move the stock price to Rs. 309.00 in the buy side and Rs. 304.40 on the sell side. That is Buy side = average price + quarter sigma price and Sell side = average price - quarter sigma price). Such an exercise is carried out for four order snapshots per day for all stocks for the previous six months period.
7. From the above determined quarter sigma order size (Rs.) for each order book snap shot for each security, the median of the order sizes (Rs.) for buy side and sell side separately, are computed for all the order snapshots taken together for the last six months.
8. The average of the median order sizes for buy and sell side are taken as the median quarter sigma order size for the security.
9. The securities whose median quarter sigma order size is equal to or greater than Rs. 0.5 million (Rs. 5 Lacs) qualify for inclusion in the F&O segment.

Futures & Options contracts may be introduced on new securities which meet the above mentioned eligibility criteria, subject to approval by SEBI.

At what frequency are these numbers calculated?

New securities being introduced in the F&O segment are based on the eligibility criteria which take into consideration average daily market capitalization, average daily traded value and the quarter sigma values and as approved by SEBI. The average daily market capitalisation and the average daily traded value would be computed on the 15th of each month, on a rolling basis, to arrive at the list of top 500 securities. Similarly, the quarter sigma order size in a stock would also be calculated on the 15th of each month, on a rolling basis, considering the order book snapshots of securities in the previous six months.

Can the stocks determined as per above criteria change almost every month?

The number of eligible securities may vary from month to month depending upon the changes in quarter sigma order sizes, average daily market capitalisation & average daily traded value calculated every month on a rolling basis for the past six month.

What is the procedure for introduction and dropping of securities after arriving at the conclusions using above criteria?

Consequently, the procedure for introducing and dropping securities on which option and future contracts are traded, as stipulated by SEBI in its circular SMDRP/DC/CIR -13/02 dated Dec 18, 2002, would be as follows :

• Options and futures may be introduced on new securities when they meet the eligibility criteria and are approved by SEBI.

• If an existing security fails to meet the eligibility criteria for three months consecutively, then no fresh month contract shall be issued on that security. However, the existing unexpired contracts may be permitted to trade till expiry and new strikes may also be introduced in the existing contract months.

• The Exchange may compulsorily close out all derivative contract positions in a particular underlying when that underlying has ceased to satisfy the eligibility criteria or the Exchange is of the view that the continuance of derivative contracts on such underlying is detrimental to the interest of the market, keeping in view the market integrity and safety.

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