Demystifying the F&O Ban: Its Impact and Working in the Indian Stock Market

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What is a F&O ban, and how does it work?

A Futures and Options ban (F&O ban), enforced by the Securities and Exchange Board of India (SEBI) and executed by the National Stock Exchange (NSE), occurs when the combined open interest (OI) for a stock's derivatives contract crosses 95% of the market-wide position limit (MWPL). MWPL is set to avoid excessive speculation in specific securities and maintain orderly trading. The ban is lifted when the total OI comes down to 80% or below the MWPL. This allows the normal trading of the stock in the F&O segment. However, please note that the ban period is not applicable for index F&O contracts.

What is Open Interest

Open Interest (OI) refers to the total number of outstanding derivative contracts, like futures and options, that have not been settled for an asset. For example, if you buy a futures contract (which means you're agreeing to buy a certain stock at a certain price in the future), and someone else sells that futures contract (agreeing to sell the stock at the agreed price), a new futures contract has been created, and the open interest increases by one. If you later decide to sell your futures contract and someone else decides to buy it, that original futures contract is closed, and the open interest decreases by one.

What are Market Wide Positions Limits?

Market-Wide Position Limit (MWPL) is a risk management measure used in the Indian stock market. It is the maximum number of open derivative contracts that can be created for a specific stock at any point in time. This limit is set by SEBI to ensure smooth trading without undue speculation that could disrupt market orderliness.

For example, if a stock's MWPL is 500,000 contracts, market participants collectively cannot hold more than 500,000 open futures and options contracts for that stock.

A market-wide position limit is expressed in the number of shares. Simply speaking, it is lower of

  • 30 times the average number of shares traded daily during the previous calendar month in the cash segment; or,
  • 20% of the number of shares held by non-promoters (sometimes also called free float shares)

MWPL is calculated for every month.

Why is the F&O Ban implemented and what happens if it is violated?

The objective behind putting a selected stock on the F&O ban list is to tackle the excessive upsurge and speculative trading in that stock. If traders try to take fresh positions or increase their position on a stock that has been put in the F&O ban list, they are levied a penalty of 1% of the value of the increase in position. This is subject to a maximum limit of Rs 5,000, and a maximum of Rs 1 lakh.

How do you trade in F&O-banned stocks?

F&O ban prevents you from creating a new position with the stocks placed under the list, but you can square off or sell your existing holdings. Alternatively, you can trade in the cash segment, which doesn’t have any such limit.

How does the ban affect stock price?

It is worth noting that when F&O ban is imposed on a stock, and no new positions are taken, the stock price will continue to remain depressed until the ban is removed. Now let's understand this with the help of a case study.

Case in point: Zee Entertainment Enterprises (which was subjected to a F&O ban on June 15)

  • Pre-ban closing stock price on June 14: Rs 194.85
  • Immediate aftermath: A steep 4% fall in stock price to close at Rs 186.60 on June 15.
  • Subsequent price trend: A consistent decline to close at Rs 173.30 by June 20, which is a 11% drop from the pre-ban closing price.
  • Ban lifted on June 21: A swift rebound of 4% in the stock price to Rs 180.30 compared to the previous day's closing.

How to track MWPL?

Numerous external platforms and applications display market-wide positions of F&O stocks. This feature is also typically provided in a dedicated window by most brokerage firms.

Additionally, the National Stock Exchange (NSE) enables a feature in the trading system to trigger an alert when the open interest on the NSE surpasses 60% of the predefined MWPL for a specific security in the F&O contract. These alerts are set to appear at 10-minute intervals.

Conclusion

Remember, while an F&O ban might affect a stock's price, it is just one of many factors that can influence the stock price. Other aspects such as the company's fundamentals, economic factors, market sentiment, and news related to the company also play a significant role.

In conclusion, understanding the implications of the Futures and Options (F&O) ban in the Indian stock market is crucial for investors.  Liquide, a leading investment platform, offers a range of features to help navigate through such market conditions. With LiMo, their AI-powered bot, expert-recommended trade setups, real-time tracking, and portfolio health checkups, Liquide empowers investors with valuable tools and support. To take advantage of these features and enhance your investment journey, download the Liquide app from the Google Play Store or Apple Google Play Store.