Futures and Options (F&O), popularly known as ‘Derivatives’, are financial contracts, which derive their value from an underlying asset. The underlying asset can be shares, stock indices, currencies, commodities, etc. Futures and Options are traded on stock exchanges like NSE and BSE. For all stocks that are traded under the F&O segment, exchanges set a Market-Wide Positions Limit (MWPL), which is the maximum number of contracts that can be open at any point of time (open interest). If at any point of time open interest of any stock crosses 95% of the MWPL, all the F&O contracts relevant to that stock enter a ban period. Before understanding the F&O ban in detail, let us understand basic concepts relevant to it.
Meaning of Futures & Options
Both futures and options are part of the derivative market in the stock exchanges. These contracts are signed by two parties for trading stock at a predetermined price at a later date. As mentioned earlier, F&O derive their prices from an underlying asset. These contracts may also be used to hedge market risks involved in stock markets by fixing the prices beforehand. Though both futures and options are derivative securities, they are different from each other in terms of obligations imposed on individuals under a contract. Futures imposes a liability on the investor requiring investors to honor the terms of the contract on the due date, whereas option contracts give individuals the right but not obligation to do so. Generally, no delivery takes place on the F&O segment.
Meaning of Market-Wide Position Limit (MWPL)
MWPL is a widely used parameter for the analysis of stocks that trade on the derivative segment of the financial market. MWPL is the maximum number of open positions allowed on F&O contracts of a specific underlying stock. In simple words, MWPL sets the maximum number of contracts that can be open at any point in time for a particular underlying stock. MWPL is only applicable for stocks and not for other underlying assets of derivatives. MWPL is the lower of the:
- 30 times the average number of shares daily traded during the preceding month in the cash segment of the exchange, or
- 20% of the number of shares held by non-promoters, which means 20% of the free float.
Stock exchanges release the MWPL for specific stocks traded in the derivative segment monthly.
F&O Ban Explained
If the open interest of any stock crosses 95% of the MWPL taking all the futures and options contracts of the stock into consideration, then all the F&O contracts of that stock enter a ban period. The percentage combined open interest of a stock used to determine the F&O ban is calculated as follows:
Percentage Combined Open Interest = (Combined Open Interest across all F&O contracts of a stock/MWPL of the stock) X 100
Therefore, if the percentage combined open interest for any stock exceeds 95% of the MWPL set by the exchanges, then the stock goes into a ban period in the F&O segment. The main objective behind the F&O ban is to curb excessive speculative activity. At the time when a stock is under an F&O ban, no fresh positions are allowed for any future or options contract in that particular stock. Investors are only permitted to exit their existing positions during the ban period. The F&O ban is lifted only when the open interest in that stock falls below 80% of the MWPL.
Normally, when any stock enters the F&O ban i.e., crosses the 95% threshold, it implies that only square offs are allowed on that particular stock in the F&O segment. Therefore, either the longs will get liquidated (long unwinding), or the shorts will be covered (short covering). Because no new positions are allowed to be opened, the stock price should remain depressed till the long unwinding and short-covering stops. The stocks that are nearing their MWPL limit of 95% may witness a sudden spurt in their MWPL as investors will prefer to offset positions to prevent the stock from entering the F&O ban.
Hence, the availability of information about the F&O ban and related details beforehand to the investors enables them to make an informed decision about their position in such stocks that are trading near MWPL limits set by the exchanges.
Rollover under F&O Ban
A rollover means switching from the front-month contract that is close to expiration to another contract in further-out months, carrying forward your future position. Rollover is simply the process of moving a position from one month to another i.e., closing position in the contract that is about to expire and opening a similar position in further month contracts. According to the SEBI circulars and clarifications by exchanges, the rollover of contracts in the ban period is not permissible. Therefore, under the F&O ban, investors are only allowed to exit the existing position and no rollover of contracts is allowed.
Where to check the F&O Ban List
The F&O ban list shows the underlying stocks of futures and options whose combined open interest in all F&O contracts crosses 95% of the MWPL. Stock exchanges release the F&O ban list on a day-to-day basis and this information is widely available on the official website of NSE and BSE, and on other financial-related websites such as moneycontrol, niftytrader, and so on.
Along with the F&O ban list, investors should also keep an eye on possible entrants and possible exits from the ban list. Possible entrants are a stock that has MWPL above 80% and thus there is a possibility that it might enter the ban soon, whereas Possible exits show F&O securities that are already on the ban list and its MWPL has started dropping below 95% and thus there are chances that it might exit the ban list in the near future. To check these lists, Click Here.