F&O ban: Why a stock gets banned and things you should keep in mind as a trader
You would have seen reports of certain stocks entering the Future and Options (F&O) ban list. And if you hold an F&O position in any such stock, you will face certain restrictions to trade in it. One big restriction is that you cannot take any new positions in the stock.
So, how does a share enter the F&O ban list? Here’s all you need to know about the F&O ban, the F&O ban list, and allied terminologies.
What is F&O ban time?
When a stock enters the ban list, trading in its derivatives products, like futures and options, is limited to open positions. The curb in trading will be lifted only when the open interest (OI) in the stock falls below 80%. It is important to emphasise that the F&O ban only applies to equities and not to market indexes. Those trading in indices would not be affected by the F&O prohibitions.
Open interest, or OI, is the number of outstanding positions in the futures and options on an exchange. It is calculated by adding up net open positions/contracts in the stock/index's derivative.
Another term you need to know is Market Wide Position Limit (MWPL). This is a trading limit for stocks traded in the derivatives market. This limit set by stock exchanges specifies the maximum number of open positions allowed across all F&O contracts of an underlying stock. The MWPL is 20% of the free float market capitalisation of a stock. This limit does not apply to indices.
MWPL can either be negative or positive. When the aggregate demand for the specific security is more than 95% of the MWPL, all the F&O contracts in that stock could be subject to a trading halt, known as the F&O ban. From that time onwards, no new positions in security can be created. This is when the F&O contracts in the stock are said to be “banned”.
Impact of F&O ban on share price
When a stock is in an F&O ban, no fresh purchases are allowed; only sale is permitted in the F&O segment. So, does this impact the price of the stock? Excessive speculation undermines market stability, causing tremendous damage to investor sentiments. So, the F&O ban is used mainly to keep the quality of the stock high. However, the ban on taking new positions results in a fall in the stock price.
The F&O ban is a significant burden if investors are unaware of the restrictions it places on them. For instance, in an F&O ban period, investors would be only able to close out positions and not take any fresh positions. They may even be forced to liquidate the shares at a price that is generally unfavourable to them due to the lack of other alternatives. Investors must know market speculations and keep a tab on when the stock could enter a ban period.
The National Stock Exchange (NSE) trading system warns whenever the Open Interest in an options contract exceeds 60% of the given MWPL. The warning generally appears on your screen once every 10 minutes.
Choosing securities and indices for F&O trading
For profitable trading in securities and indices in F&O, make sure
The MWPL is not less than Rs 500 crore.
The average delivery value in the cash market is not less than Rs 10,00,00,000 in the last six months.
Making trading in F&O easy
The first step is to create a trading account with the broker where you can quickly buy and sell F&O contracts. These contracts can be bought and sold through broking companies registered with the BSE or NSE.
Once the account is created, you must log in to the portal, choose the mobile application option, and browse through the available options.
After choosing the platform, you must research the F&O contracts available.
After making a choice, you must enter the order details to buy the F&O contract at the strike price. This is the price at which the call or put options are available.
One of the most critical factors you need to consider to help negotiate the contract price is the spot price. Spot price helps in the immediate buy or sell of the commodity, just like any asset currency or commodity has the current market price.
Q. How can you trade during an F&O ban?
F&O ban prevents the opening of any new positions in the derivatives of the stock. But you square off your already open positions. Before you start trading, you must know the meaning and intricacies of the F&O ban.
Q. What happens when a stock is under an F&O ban?
The stock exchange will freeze trading in the derivative contracts of stocks in the ban list.
Q. Why are stocks banned under F&O?
An F&O ban is a regulatory measure to prevent excessive speculation in a stock. The exchange places the stock under the ban list when speculation in the stock crosses a specific mark.
In this blog, we learn about the relationship between calls, puts and the underlying futures contract, called Put-call parity.