In NSE bid to curb freak trade impact, stop loss orders in options may go

The National Stock Exchange (NSE) is reportedly weighing the possibility of withdrawing the stop loss market order facility for options trading, so as to curb losses in the wake of freak trades.

It may be recalled that many incidents of freak trades have occurred in the recent past in the F&O segment, and stop loss market order executions were done at some prices entirely randomly. A freak trade is a situation wherein the price of a contract trades at unusual levels for a few seconds before it reverts to the normal price level. An abrupt drop or increase happens, which could result in the triggering of stop losses. The latest incident of a freak trade occurred on September 14, while at least six such incidents have been reported in the news over the past two months. In the September 14-incident, futures contracts of some blue-chip companies saw a 10 per cent increase in price. In August, news reports showed that the NSE saw some unusual price increases in a few options contracts.

What is the stop loss market order in options trading?

The stop loss market order facility helps traders choose the market’s best price instead of picking their own price. After a trade input their price for a call or put options, freak trades will not be able to trigger an automatic stop loss. This may result in unexpected and large losses for traders, as per experts. However, such freak trades may still be curbed if traders place limit orders rather than stop loss market orders.

What is the difference between stop loss limit order and stop loss market order?

A stop loss order is placed so as to sell or buy a particular stock after it reaches a specific price. The stop loss has been designed in order to curb a trader’s loss on security positions. On the other hand, a stop-limit order imposes a limit on the price of execution. So, if there’s a buy limit order, it will be executed at the limit or lower price, while for a sell limit order, it will be executed at the limit or higher price. This ensures that a trader is able to control prices better. In a stop-limit order, two prices include stop price and the limit price.

Stop loss market orders automatically sell a security if it reaches the price limit that has been set, but when the price of the security dips below the predetermined price level, the stop loss order turns into a market order. In this scenario, instructions to sell may be executed at any price. So, a freak trade at a price below the preset level at the same contract would still trigger the stop loss. For instance, if you have bought a call option at Rs 70 and stop loss at Rs 60, a freak trade occurring at Rs 40 would trigger the stop loss. Although the freak trade lasts only a few seconds, traders who tend to use stop loss market orders may face trouble in those few seconds.

According to news reports, the NSE has planned the introduction of a four-step process for confirmation procedure for options trading so as to restrict any unusual price movements. This process is already in place for futures contracts, wherein alerts are given out if the order price is equal to or greater than a specific reference price percentage for by orders. The alerts are generated for sell orders when the order price is equal to or lower than the reference price percentage. This reference price percentage or threshold is 5 per cent and 3 per cent for stock and index futures, respectively.

Experts note that the four-step process may also lower the chances of any manual human errors, also called fat-finger errors, and make it difficult for certain elements to enter orders that veer away too widely from the normal price range.

Conclusion

The NSE is looking at withdrawing the stop loss market order facility for options trading in order to curb losses to traders, in the event of a freak trade. The NSE has seen incidents of freak trades in the F&O segment.

FAQs

What is a stop loss market order in options?

A stop loss market order is an advance instruction to sell when the price reaches a specific level, and is used to limit losses or gains in a certain trade. Stop loss orders are automated orders.

What is a stop limit order?

Stop limit orders ensure that there’s a limit on the price of execution. If there’s a buy limit order, it will be executed at the limit or lower price, while for a sell limit order, it will be executed at the limit or higher price.

What is the NSE planning to curb the impact of freak trades?

The NSE plans to withdraw the stop loss market orders facility in options trading so that the impact of freak trades is lowered or done away with.