Last Updated on May 24, 2022 by Anjali Chourasiya

Futures and options constitute the derivatives market. In F&O trading, you do not buy or sell securities when you make a trade. Instead, you agree to buy or sell a security at a later date and at a predefined price. F&O trading, therefore, helps you make profits by speculating on the future price movements of securities. You can do F&O trading in stocks, currencies, commodities, and other securities that are traded on the capital market.

However, when it comes to F&O trading, there is a limit upon quantities that one can trade. If the limit is exceeded, the National Stock Exchange (NSE) imposes a ban on F&O trading in securities. Let’s understand how and why the ban is imposed and what happens to the securities under ban.

What is the securities ban in F & O?

A securities ban in F&O trading is when the NSE imposes a ban on new futures and options contracts on a particular stock. This means that traders and investors cannot open new positions or enter into new futures and options contracts on that security. 

However, existing open positions can be closed even in securities under ban. This means that if you have an open futures or options contract on a stock, and the security is placed under a ban, you can still close your position after the ban has been imposed. 

For example, say, you entered into a futures contract in stock A on 10 August. The exercise date of the contract is 31 August. Assume, on 20 August, an F&O ban is placed on stock A. So, from 20 August, you will not be able to buy any more futures or options contracts of stock A. However, the contract that you have bought on 10 August would be closed on 31 August, even though a ban has been enforced on the security.

Why is the security ban imposed in F&O?

The NSE imposes a ban on new F&O trading in stocks to limit speculative activity in the market. Futures and options contracts are speculative contracts wherein traders speculate the price movements. Too much speculation might adversely affect the stock prices and might hamper the market mechanisms. Also, a trader or company with a lump sum amount may try to manipulate the market by heavily pumping or dumping a stock of their interest. 

However, the ban is imposed only in the case of F&Os for stocks. Index F&Os are not considered for the ban. Moreover, the ban does not affect normal intraday or delivery trading in the stock. This is because the trading activities are normal wherein investors pay up the total cost of the stock when opening a trade.

When is the securities ban imposed?

The NSE monitors the total open positions in futures and options contracts of each stock. There is a specific limit up to which new F&O contracts are allowed in each stock. If the limit is breached, a ban is issued by the NSE. The entire concept of securities under ban depends on MWPL – Market Wide Position Limit. Let us understand that in detail below.

The concept of MWPL

Since the ban depends on the MWPL of the stock, understanding the term is also very important. 

MWPL is determined as the lowest of the following:

  • 30 times the average number of shares traded on the cash market in the stock exchanges in the last month
  • 20% of the shares that are held on a free-float basis, i.e., shares that are not owned by the promoters of the company

In other words, this limit is the maximum number of open positions that a particular stock is allowed in F&O trading. The MWPL limit changes regularly with a change in the number of shares traded in the market every day. The NSE keeps track of the MWPL limit and updates it regularly to tally the aggregate open positions in the derivatives market.

The limit is maintained at 95% of the MWPL. So, if the aggregate value of all open futures and options contracts exceeds 95% of the stock’s MWPL, the NSE imposes a ban on the stock. 

There is no specified time limit on the ban. The ban remains effective till the aggregate value of all open positions of the futures and options contracts on the stock does not fall to 80% of the MWPL or below. Once the 80% limit is reached, normal trading can resume.

The NSE releases a circular everyday post 6:00 PM to inform traders and investors on securities under ban. Security could be under ban for as little as one trading session. 

For example, the stocks of the company – Vodafone Idea – experienced wide swings, due to management changes, new AGR definitions and debt woes. The NSE imposed a security ban on it. Look at what the circular issued by NSE read: 

“It is hereby informed that all clients/members shall trade in the derivative contracts of said security only to decrease their positions through offsetting positions,” the stock exchange said. “Any increase in open positions shall attract appropriate penal and disciplinary action”.

The implication of trading on securities under ban

As mentioned earlier, traders are prohibited from opening any new positions on stocks that are banned. If, however, any trader disobeys the ban and opens a new position in the derivatives market, they would face a penalty on the trade. The penalty would be calculated as 1% of the value of the increased position in the stock, subject to a minimum of Rs. 5,000 and a maximum of Rs. 1 lakh.

How the ban affects you?

A securities ban in F&O impacts you directly if you trade in futures and options. If you open a new trade on any security under ban, you will incur a penalty. As such, you should be aware of the ban as and when it is imposed.

Even if you trade in the cash segment of the market, a ban on the stock might depress the price of the stock, thereby incurring losses for a new trader. So, you should be mindful of the imposition of an F&O ban and keep track of the stock prices.

The NSE publishes alerts on its portal if the aggregate open positions on a stocks’ futures and options contracts exceed 60% of the MWPL. It helps the traders assess whether a ban is imminent or not so that they can make informed trading decisions.

Conclusion

Trading in F&O can be risker than perceived. As a trader, you should keep yourself updated on all possible market activities so that you can manage your portfolio effectively. It is also paramount for traders to not only follow every update and news on the markets but also understand the intrinsic details of terms like MWPL and the penalty imposed by exchanges for violation of SEBI rules.