Impact of F&O Ban on Share Prices

If a stock is traded in futures and options in derivatives market, then it becomes subjected to a trading limit called market-wide positions limit or the MWPL. This is a limit set by the stock exchange, which states the maximum number of contracts that can be open at any particular time. This is referred to as open interest which consists of all outstanding buy and sell positions in the futures and options contract. MWPL is set as either -
1. 30 times the average number of shares which are traded daily during the preceding month, or
2. 20 percent of the number of shares held by non-promoters; depending on whichever of these two figures is lower.

When the aggregate open interest of any particular stock crosses 95 percent of the market-wide positions limit, all the F&O contracts of that stock are given a trading ban, which is termed as F&O ban.During the ban period, no new positions can be opened for any of the F&O contracts in the stock which is under the ban period. A trader will only be permitted to exist the previously opened positions in this ban period. The ban is lifted if and when the open interest of the stock falls below 80 percent.

One important thing to note is that the F&O bans are placed only on stocks and not on market indices. Traders who trade in index do not face any consequences of F&O bans.

F&O ban is a regulatory measure through which it is intended to prevent excessive upsurge and speculative trading. When speculation in the market in relation to a stock crosses a particular limit set by the stock exchange, the stock exchange places the stock under F&O ban.When a stock enters ban period, any new position cannot be opened for that stock to prevent the excessive speculation. The only kind of trading which is permitted in this period is to exit the pre-existing positions or to square off the existing positions. If a trader tries to open a new position on a stock that has been put under the F&O ban period, the trader is levied a penalty which amounts to 1% of the value of the increased position of that stock.

The impact of F&O ban on the prices of shares which are put under the ban period is immense and a trader who wants to trade in futures and options must be aware of this. As it is discussed already in this article, stock exchanges put certain stocks in the F&O ban list in order to regulate excessive speculative activity in the market with respect to that stock. Excessive speculation hurts the stability of the trading market, and can prove to be extremely harmful when it comes to investor sentiment across the market. The F&O ban, which prevents trading in the stocks that are in the ban list, is also used to control the high volatility of the stock. Because of the restrictions on trades, any stock which is in the ban list witnesses a continuous decrease in its price. It is also influenced by the fact that investors who had opened any positions on the stock ie. bought futures and options in the stock are forced square off their positions which means they have to cut profits on their trades.

Because they will be forced to square off their positions in a stock, investors suffer deeply because of F&O ban in case they were unaware of the ban period. Since they will not have another option, they have to square off their positions in a price that will most probably be unfavourable to them. To avoid this kind of loss, investors need to be aware of the speculations in the market and they need to be alert in case a stock is entering the ban period. The NSE (National Stock Exchange) offers a crucial feature in this regard, as on their trading system, an alert is displayed once the open interest of futures and options contracts in a stock crosses 60 percent of the predetermined market-wide positions limit. The alerts are displayed in intervals of 10 minutes.

Excessive speculation on a stock, especially when it affects the free float of the stocks can pose a significant threat to small investors. Free float of a stock is a measure of availability of stocks in the stock market for public investment. Investors with malicious intent can try to exploit such scenarios and use it to manipulate the liquidity of the stock. Therefore, it is required of traders to be extremely cautious and alert while trading in futures and options.

Even though this particular discussion on the F&O ban might have projected a negative scenario in terms of trading in futures and options, trading in the derivatives market can prove to be extremely profitable for investors if they are highly alert on the situation and have the necessary market related information and knowledge.There are certain trends in the market that can be beneficial for the traders as well. For an example, the price of the stock might continue to decrease once it is put in the ban list, however, a common trend which is witnessed by traders is an increase in the price of the shares once the stock is out of the ban period.

Trading in the stock market is subject to market risk. For more information regarding investments, visit Nirmal Bang.