Notes for NISM 8 Equity Derivatives Exam 2025 – Chapter 6: Trading Mechanism 

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). 

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