Why do stock exchanges place stocks under F&O ban?
If you are new to trading in Futures and Options (F&O) segment, you need to know about stock exchanges placing some stocks under a ban period. During this period, traders cannot open any fresh position in the stock, but they can reduce their positions by offsetting their contracts.
A stock exchange places a stock under a ban period when the combined open interest (OI) in the F&O segment of the stock crosses 95% of the market wide position limit (MWPL). The OI refers to all outstanding buy and sell positions in the stock or index futures and options contracts, while the MWPL refers to the total number of shares of a given stock that can be traded in the F&O segment at any given point of time. MWPL is determined as lower of 30x the average number of shares traded daily in cash segment during previous month, or 20% of the free float (non-promoter holding) of the stock.
Therefore, when the combined OI in the F&O segment crosses the specified limit of 95% of MWPL, the stock exchange places the stock under a ban period.The opening of new positions in futures and options of the stock is banned during the ban period and only when the OI reduces to 80% or less of the MWPL, the ban on the stock is removed. Despite the ban in F&O, intraday trading or trading in cash segment is permitted in the stock. Also, no such ban applies to index futures and options.
Depending on whether the market is in bullish or bearish phase, such F&O ban on a stockcan inflict heavy losses for the bulls or the bears holding open positions in the stock. This is because they may be forced to square off their existing positions in the stock futures or options.
The stock exchanges impose F&O ban on a stock to prevent runaway speculation in the stock as rampant speculation can lead to defaults, which can ruin the health of the stock markets.