When the open interest of market-wide position limit (MWPL) for a stock surpasses 95%, the stock comes under a ban in the futures and options (F&O) division. The open interest combines the total F&O contracts for all the months.
If a security comes under the trading ban, you can only square off the position of that stock holding in futures and options. You cannot open new places either in futures or in options if a trading ban is imposed.
Market-wide position limit (MWPL)
Market-wide position limit (MWPL) is a limit that shows the maximum number of unsettled option contracts for a derivative stock. Currently, the MWPL for Indian derivative stocks is 95%.
If the open interest of a share’s MWPL is greater than 95 per cent, the share is banned from trading in the futures and options market. Open interest is the final number of outstanding obligations held by market members at the end of each day. Open interest measures the fundamental level of activity in the futures market.
The concept of market-wide position limit is applied to securities in the futures and options (F&O) section. Every month, the stock exchange publishes data for MWPL of each security in the F&O section. Index derivatives are not subjected to the MWPL.
The MWPL of securities should be:
- Less than (or equal to) 20 per cent of the free float stock, and
- Thirty times the previous month’s average quantity of stocks regularly traded in the exchange’s cash market.
The National Stock Exchange (NSE) gives a trading system that notifies when the open interest of futures and contracts in security exceeds 60% of the security’s market-wide position limit. These notifications are highlighted at the 10-minute time frame.
Exemplified explanation of market-wide position limit (MWPL)
To understand the securities ban, it is essential to grasp the basics of market-wide position limit (MWPL). MWPL is determined by calculating 20% of the free float market cap of a company.
Suppose a company has a 10 crore net share volume. From this market cap of shares, five crore shares are held by promoters and thus form the restricted stock. The remaining stock of five crore constitutes the free-float market cap, which is open for trade on the free market.
Taking the above example, 20% of the free float market cap will be,
20% x 5 crore = 1 crore
Therefore, the company’s market-wide position limit is 1 crore shares.
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20% of the free float market cap is called the market-wide position limit (MWPL). When MWPL-to-open interest crosses 95%, a trading ban is imposed on a share for the next trading session. The ban continues until the MWPL comes below 80%.
During Security in Ban
When security is under the ban, the only transaction that traders can do is reducing their position. They can reduce the place by selling the original position. To put it simply, you cannot open a new position until the security ban is lifted in F&O Segment. However, traders may opt for intraday positions as it is not related to open interest.
Why is a ban on securities imposed?
The vital reason why exchanges impose a ban on security in the F&O segment is to reduce the volatility in particular shares on both sides. The ban saves retail investors from significant losses. It also gives time to investors for rethinking their positions. Traders are not permitted to open any new positions in securities during a ban period. But they can exit already opened positions.
Penalty for breaching the ban
If a trader breaches the F&O ban, i.e., raises or opens a new position in security during the ban period, they are levied a fine of 1% of the rising position’s value. The lowest penalty limit is set at Rs 5,000, and the upper limit is Rs 1,00,000.
Ban resumption and normal F&O trading
After the ban, regular trading in securities only resumes when total open interest on all exchanges comes below 80% or less of the MWPL. In simple terms, when the open interest drops to 80% or less, stocks come out of the ban, and regular trading resumes.
Suppose a company’s market wide position limit is 80 crore shares and open interest is 78 crore shares. By calculating the percentage, i.e.,
{Open Interest / MWPL} x 100
{78 / 80} x 100 = 97.5,
The open interest comes out to be 97.5%. As the percentage is above 95%, the ban will remain on the company’s securities. It will only come out of the prohibition if the rate slips below 80%.
So, if the open interest reaches, say, 60 crore shares, which will mean
60/80 x 100 = 75%.
Thus, the share will be under 80% and will come out of the ban.
In the end, it is essential to remember that securities in the F&O segment that enter a ban period are the ones that are highly speculative and risky. Such shares are not a promising investment choice, especially for retail investors just beginning their investment journey. Still, even if you have entered such a risky transaction, you can trade the stock in the cash segment, where no such limits apply.
