What is an F&O ban? Know its impact on futures and options trades

If you are a trader in futures and options or someone who closely follows the stock market, you must have seen instances of the stock exchanges banning stocks.

Ban on stocks in F&O happens regularly, sometimes every day. 

Here is everything you need to know about what it is and why stocks go under a ban.

What is an F&O ban?

Traders use futures and options contracts to speculate price movements and hedge risks in the stock market.

The increase in speculations impacts share prices vastly, leading to constant fluctuations. When stocks become volatile due to this, they affect the overall market. The stock exchange, aiming to avoid such situations, imposes a ban on those volatile stocks to bring prices under control.

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Concepts related to F&O ban

• Futures

Futures are contracts entered into, in the stock exchange to buy and sell assets on a future date at an agreed pre-determined price.

• Options

Options are derivative contracts involving two parties where the option holder has the right to buy or sell an asset at an agreed price on a future date. The other party to the agreement is obligated to fulfil the contract.

• Open interest

Open interest refers to the number of derivative contracts in the market that have not reached the settlement date yet, meaning the contract is still active.

• Market Wide Position Limit (MWPL)

The MWPL is a limit set by the stock exchange for securities. It determines the number of derivative contracts that can be open or outstanding for a stock at a particular time.

Stock exchanges determine the MWPL of a stock based on its free float capitalisation. Both NSE and BSE have set the MWPL at 20% of a stock’s free float capitalisation.

Also read: How to trade in options and maximise your profit?

When and why does the stock exchange impose an F&O ban?

If the open interest of a stock goes beyond 95% of its MWPL, the stock exchange imposes an F&O ban on that stock. The ban is lifted once the open interest comes under 80% of MWPL. In some cases, it takes only one day for the open interest to go below the limit. Sometimes, it takes multiple days.

For example: Consider the stock of ABC Ltd with a free float market capitalisation of ₹ 2,00,000.

The MWPL will be ₹ 2,00,000 * 20% = 40,000 contracts.

When the open interest (the number of outstanding contracts) goes beyond 38,000 contracts (40,000 * 95%), the exchange imposes a ban.

• What happens when a stock is in an F&O ban?

When the number of open contracts for a stock is high, it indicates the high level of speculation in the market that can affect stock prices. It also shows illegal traders the potential opportunities to manipulate the market.

Hence, the stock exchange tries to control these activities through a ban. Traders cannot enter into new or additional positions during this period, which impacts the stock prices and creates stability.

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How are share prices impacted? 

The influence of a ban on the price of stocks depends on other factors like the past performance of the stock and the creditworthiness of the company. The exchange restricts traders from entering into new contracts until it lifts the ban on the stock, which affects the quantity traded, thereby impacting the stock prices.

An F&O ban on stock with a good reputation does not impact the stock prices too much. The price is usually stable or has a slight increase or decrease.

A ban on stocks that are gloomy has a strong effect on the prices. The ban may lead to a rapid decrease in prices.

What does the ban mean to traders?

• The ban applies only to certain stocks and not the entire market, meaning traders can continue to trade in other stocks as usual.
• The ban indicates that traders cannot enter into any new contracts. The existing contracts in the derivative market will remain valid. 
• The restriction is only on entry, traders are free to exit their positions or square off, even during the ban.
• The F&O ban applies to stocks and not to indices. So, traders entering into derivative contracts with index as their underlying asset will not have any impact from the ban.
• The exchange penalises traders who violate the F&O ban by increasing their positions or entering into new contracts. A fine of 1% (with a minimum limit of ₹ 5,000 and an upper limit of ₹ 1,00,000) of the new or additional position is chargeable by the exchange.
• Traders can continue to trade the stocks under the ban in the cash market. Since the cash market deals with spot payments, it is not bound by the rules of the derivative market, where trades settle on a future date.

Sourcing the list of stocks under the F&O ban

The National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) publish details of stocks in the F&O ban period daily. 

NSE F&O ban list: https://www.nseindia.com/products-services/equity-derivatives-risk-management-sec-ban

BSE F&O ban list: https://www.bseindia.com/markets/Derivatives/DeriReports/MWPL.html

The updates of securities in the ban period are also available on various news and stock broking websites.

Both exchanges provide the list of stocks in derivative contracts, mentioning their open interest and market-wide position limits. Traders interested in future and option contracts can keep a regular check on this list. It helps them assess the stocks that will soon go under a ban, enabling them to take necessary measures.

Examples of stock symbols that were part of the recent F&O ban:

Notice that some stocks have been removed the next day, while some others continue to be banned. The stocks removed indicate that the open interest has come below 80%, and the stocks that continue indicate that the open interest is not below 80% yet.

Source: NSE

Bottomline

The knowledge of the F&O ban is a significant concept for traders in the derivatives market. It is essential to keep track of the stocks, their open interest and MWPL, to ascertain in advance the list of stocks that can potentially go under the F&O ban.

Being ignorant of this can cost the traders heavily in the form of losses and fines.