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Why is intraday trading not allowed for contracts if the underlying security is under a ban period

26 Jul 2023

Trading in the stock market entails inherent market risks, which necessitates stringent regulations. One such restriction pertains to futures and options (F&O) trading known as the F&O ban. 

In the derivative market, stocks have a trading limit called MWPL, which defines the maximum number of open contracts. When demand exceeds 95% of MWPL, a trading halt, and F&O ban, is imposed. 

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During this period, initiating new positions in banned stocks is prohibited, emphasising the need for regulatory compliance. In this blog, we will discover the reasons behind the prohibition of initiating new positions during a ban period. 

Why does underlying security enter a ban period?

As discussed above, when the open interest of a stock’s F&O contracts surpasses 95% of the Market wide Positions Limits (MWPL), it enters a ban period. New positions are not allowed during this time. But investors can exit open positions. The ban is revoked solely when the open interest drops below 80%. Notably, the stock can still be traded in the cash segment without any restrictions or limits. 

What are the impacts of the underlying security ban on share prices?

Intraday trading of contracts during the ban period has the following impacts on shares prices: 

Market D​ynamics

During the F&O bans, the Indian stock market usually experiences reduced liquidity. This results in lower volumes and narrower trading ranges. However, significant market-moving news or events can still cause sharp movement during these periods. Thus, traders should remain mindful of the potential impact of the F&O bans and adjust their trading strategies accordingly to adapt to the prevailing market conditions. 

Volatility and Investors' Sentiment

F&O bans in Indian markets, typically imposed on the last Friday of each month, can impact volatility and investor sentiment. Trading in futures and options contracts is restricted during these periods, leading to lower liquidity and narrower trading ranges. Consequently, the market may experience increased volatility due to reduced participation. Investor sentiment can also be influenced, as some may hesitate to trade in a less liquid market. It is crucial to acknowledge the potential impact of F&O bans and adapt trading strategies accordingly, considering the unique dynamics of these periods.   

What are the strategies used for navigating share prices during the ban period?

During the ban period in Indian stock markets, consider these strategies:

  1. Utilise stop-losses to limit losses if the stock price falls. 
  2. Focus on liquid stocks for easier buying and selling. 
  3. Trade with smaller positions to reduce risks. 
  4. Exercise patience and avoid aggressive trading due to increased market volatility. 

How underlying security ban affects trading volumes and liquidity?

Stocks can be placed on the F&O ban list either temporarily or permanently. Temporary bans occur when a stock’s open interest surpasses 95% of MWPL, and once it falls below 80%. Share prices may or may not be significantly affected during temporary bans.

On the other hand, stocks can be permanently banned if the company violates exchange or SEBI regulations, such as insufficient liquidity, inadequate market capitalization, or management fraud. Permanent bans can have a profound impact on share prices, as seen in the example of Satyam Computer Services, where share prices plummeted. Remember to consider the implications of both temporary and permanent bans when evaluating the trading environment. 

Conclusion

While the discussion on F&O bans may seem negative, trading in the derivatives market can be highly profitable with proper alertness, market information, and knowledge. There are favourable trends that traders can benefit from as well. For instance, after a stock is put on the ban list, its price may continue to decrease. However, a common trend observed by traders is a subsequent increase in share prices once the ban period ends. This highlights the potential for gains if traders carefully monitor and capitalise on market movements. Therefore, despite the limitations imposed by F&O bans, opportunities for profitable trading exist for those who remain informed and adaptable to market dynamics. 

 

Related Articles: 20 things you need to remember when you trade intraday | Best Intraday Trading Tips and Strategy | How to Make Profit in Intraday Trading | How to decide whether a stock is fit for intraday trading 

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