Trading Mechanism :
- Trading Mechanism: Futures and options (F&O) are standardized contracts traded electronically in India; trading is screen-based with continuous bid-offer display.
- Order Matching: Orders are matched on a price-time priority basis; unmatched orders are stored by best price and timestamp.
- Market Types: Two types exist—open outcry and electronic. India uses the electronic format for F&O.
- Entities Involved:
- Trading Member: Trades for self or clients.
- Trading-cum-Clearing Member: Clears trades for self and others.
- Professional Clearing Member: Clears trades without trading rights.
- Self-Clearing Member: Clears only self and clients’ trades.
- Participants: Clients of trading members.
- Authorized Persons: Act as representatives after sub-brokers were phased out (post-April 2019).
- Corporate Hierarchy: User roles include Corporate Manager (full access), Branch Manager (branch-level), and Dealer (individual access only).
- Client-Broker Relationship: Includes responsibilities like KYC, margin collection, separate client accounts, timely contract notes, and dispute resolution.
- Order Types:
- Time Conditions: Day orders, Immediate or Cancel (IOC).
- Price Conditions: Limit, Market, and Stop-loss orders.
- Trading Hours: Standard hours are 9:15 AM – 3:30 PM, extendable up to 11:55 PM if infrastructure permits.
- Price Bands: No fixed bands in F&O; operating/day ranges apply (typically 10% for futures). SEBI updated rules (May 24, 2024) for dynamic bands requiring more trades and participants to adjust bands, synchronized across markets, and introducing cooling-off periods.
- Objective of SEBI Rules: Enhance market stability, reduce manipulation, and smoothen price movements for a fairer trading environment.
- Trader Workstation Interface includes various windows such as ticker (futures, options, and capital market), market watch, order/trade, snap quote, and system messages.
- Order Entry: Orders must be labeled as either proprietary (‘Pro’) or client (‘Cli’), with client account numbers required for the latter.
- F&O Instruments: The system supports trading in index futures, index options, stock options, and stock futures.
Eligibility criteria for selection of stocks for derivatives trading :
- Stock Selection Criteria:
- Stocks must be among the top 500 based on average daily market capitalization and traded value over the past six months.
- Median quarter-sigma order size (MQSOS) must be ≥ ₹75 lakhs.
- Market Wide Position Limit (MWPL) must be ≥ ₹1500 crores.
- Average daily delivery value must be ≥ ₹35 crores.
- Eligible stocks on any exchange are tradable on all exchanges’ derivatives segments.
- Exit Rules:
- If a stock fails the eligibility criteria for 3 consecutive months, no new contracts are issued, but existing ones trade until expiry.
- Re-inclusion requires meeting eligibility for six consecutive months after a one-year cooling-off period.
- Product Success Framework (PSF) Exit Criteria:
- At least 15% (or 200) active trading members must trade the stock monthly.
- Stock must trade on at least 75% of days in the review period.
- Average daily turnover should be ≥ ₹75 crores.
- Average daily notional open interest should be ≥ ₹500 crores.
- Criteria apply only after 6 months of introduction.
- Derivatives Segment Exit:
- Stocks failing PSF criteria across all exchanges exit derivatives trading.
- If a stock qualifies on any exchange, it remains eligible across all.
Selection criteria of Index for trading :
- Eligibility for Index Derivatives: At least 80% of index weight must come from stocks individually eligible for derivatives; no ineligible stock can exceed 5% weight.
- Ongoing Compliance: Index eligibility is reviewed monthly. If non-compliant for 3 consecutive months, no new contracts are issued, but existing ones trade till expiry.
- Product Success Framework: Index derivatives (except flagship ones) must meet:
- Participation by 15% of all active members or 20 members (whichever is lower),
- Trading on 75% of review period days,
- ₹10 crore average daily turnover,
- ₹4 crore average daily open interest.
- Re-inclusion Rules: Excluded indices need a 6-month cooling period and SEBI approval before re-launch.
- Surrogate/Pseudo Index Use: Allowed if original index fails criteria but a similar eligible index exists. Must meet:
- 80% overlap in constituents,
- 50% common stocks,
- ≥0.90 correlation over past 6 months.
- Limitation: Only one pseudo/surrogate index allowed per exchange.
Adjustments for Corporate Actions :
- Objective of Adjustments: Ensure that the value of market participants’ positions remains unchanged on cum and ex-dates, preserving position status (ITM, ATM, OTM).
- Scope of Adjustments: May involve changes to strike price, position size, and market lot/multiplier, depending on the corporate action.
- Timing: Adjustments are executed after trading hours on the last cum-date in the cash market.
- Types of Corporate Actions:
- Stock Benefits: Bonus, splits, consolidations, rights, etc.
- Cash Benefits: Dividends.
- Adjustment Mechanism:
- Bonus/Splits/Consolidations: Adjust using an adjustment factor based on announced ratios.
- Rights: Adjustment factor derived from rights issue price and market price; includes rounding to avoid fractions.
- Extraordinary Dividends: If above 2% of the stock’s market price, strike prices are reduced accordingly; revised prices apply from ex-dividend date.
- Ordinary Dividends: No adjustment if dividend is below 2% of stock’s market value.
- Merger/Demerger:
- No new contracts post-announcement.
- All open contracts settled at the last closing price on the last cum-date.
Trading costs :
- Types of Trading Costs:
- User Charges: Include brokerages and transaction charges levied by exchanges.
- Statutory Charges: Comprise Securities Transaction Tax (STT), Goods and Services Tax (GST), Stamp Duty, and SEBI Turnover Fees.
- Breakdown of Costs:
- Brokerage: Commission charged by brokers; typically lower for intra-day trades.
- STT: Varies by transaction type (e.g., 0.10% for selling options, 0.02% for selling futures).
- Exchange Fees: Charged for trades conducted via stock exchanges, varying by trade type.
- IPFT Charges: Levied for investor protection funds (e.g., ₹10 per crore for NSE futures, plus GST).
- Additional Charges:
- GST: 18% on brokerage and transaction charges.
- Stamp Duty: 0.002% for equity futures buyers; 0.003% for equity options buyers.
- SEBI Fees: ₹10 per crore plus GST.
- Market Costs:
- Bid-Ask Spread: Difference between best buy (bid) and sell (ask) prices, representing a hidden cost.
- Impact Cost: Related to market liquidity; higher for illiquid stocks.
- Example Calculation:
- For a futures trade with a contract value of ₹8,75,000:
- Total cost: ₹507.47 (includes brokerage, STT, exchange fees, SEBI/IPFT charges, and GST).
- Important Considerations:
- Costs like stamp duty are buy-side exclusive.
- Bid-ask spreads and impact costs increase with lower market liquidity.
Algorithmic trading :
- Definition: Algorithmic trading involves executing trades using automated, pre-programmed instructions considering price, timing, and volume.
- Functionality: Algorithms are mathematical models that adapt to market conditions like prices, volumes, and timing to place buy-sell orders dynamically.
- Advantages:
- Removes emotional influence from trading decisions.
- Enables faster order execution compared to manual trading.
- High-Frequency Trading: A subset of algorithmic trading allowing tens of thousands of trades per second.
- Usage: Primarily used by institutional investors and large brokers, with some brokers offering it to retail clients in the derivatives market.
- Unregulated Platforms: Some platforms market algorithmic strategies with promises of high returns, often misleading investors.
- SEBI Guidelines:
- Warns against unregulated algo platforms.
- Prohibits brokers from referencing past or expected returns from algo strategies.
- Bans association with platforms promoting such claims.
Tracking Futures and Options data :
- Historical Context: Previously, daily newspapers were the primary source for spot and derivatives prices, but real-time data is now available on exchange websites and online trading platforms.
- Key Data Tracked:
- Trade Date: The specific date of the trade.
- Symbol: Underlying index/stock (e.g., NIFTY, ACC).
- Instrument: Contract type (e.g., FUTSTK, OPTIDX).
- Expiry Date: Contract’s expiration date.
- Option Type: Types include CE, PE (European) or CA, PA (American).
- Corporate Action Level: Indicates corporate events like dividends or symbol changes.
- Strike Price: Contract’s strike price.
- Opening/High/Low/Closing Prices: Prices at respective stages of the trading day.
- Last Traded Price: Last executed trade price for the contract.
- Open Interest: Reflects open positions multiplied by the contract’s last closing price.
- Total Traded Quantity and Value: Total contracts and their monetary value traded.
- Number of Trades: Total trades executed during the day.
- Trend Analysis in F&O Markets:
- Positive/Negative Trends: Top gainers/losers in futures.
- Futures OI Gainers/Losers: Contracts with highest/lowest % change in Open Interest.
- Active Calls and Puts: Options with high trading volumes.
- Put/Call Ratio (PCR): Ratio of trading volumes or open interest for puts vs. calls.
Introduction of Investor Risk Reduction Access (IRRA) platform :
- Investor Risk Reduction Access (IRRA) Platform
- Purpose: Protects investors during technical glitches or outages in trading members’ systems.
- Features:
- Jointly developed by exchanges for squaring off open positions or canceling pending orders.
- Supports multiple segments and exchanges.
- Triggered upon a trading member’s request during service disruptions.
- Investors are notified via email, SMS, and public notices.
- Functionality:
- Limited to closing positions and canceling orders, not initiating new ones.
- Includes an admin terminal for trading members to monitor and act on investor instructions.
- Exclusivity: Designed for individual investors, excluding algorithmic and institutional clients.
- Framework for Addressing Technical Glitches in Stock Brokers’ Systems
- Reporting Requirements:
- Notify exchanges within 1 hour of a glitch.
- Submit a Preliminary Incident Report within T+1 day and a Root Cause Analysis (RCA) within 14 days.
- RCA Details: Time, cause, impact, and corrective actions for the incident.
- Capacity Planning: Ensure systems can handle increasing investor loads.
- Centralized Reporting: Use SEBI’s Integrated SEBI Portal for Technical Glitches (iSPOT) for glitch reporting.
- Monitoring Mechanism: API-based Logging and Monitoring Mechanism (LAMA) for real-time oversight.
- Business Continuity for Interoperable Segments
- Hedging Open Positions:
- Use offsetting positions in identical or correlated products across exchanges.
- Netting positions releases margins.
- Exclusive Scrips:
- Create reserve contracts for scrips or derivatives listed exclusively on another exchange.
- Uncorrelated Indices: Develop new correlated index derivatives to facilitate hedging.
- Intimation and SOP:
- Notify SEBI and alternative trading venues within 75 minutes of an outage.
- Business continuity plan activated within 15 minutes.
- Alternative Trading Venues: NSE and BSE act as alternatives for each other with a joint Standard Operating Procedure (SOP).