Of late, there have been several instances where options contracts have traded at prices far beyond what can be considered normal aberrations. Here are some reasons why freak trades can happen either in isolation or in any combinations:
- Lack of liquidity as there are many options contracts for each F&O stock/index.
- Stop Loss Triggering can be either incidental or caused by SL hunting by HFTs.
- Fat finger trades can happen. I'll post more about this soon.
- Panic square off can happen but usually on big market moves or event days.
- The absence of a pre-defined execution Range. TER helps prevent such moves.
Below are some recent freak trades on the recent "near-week" Index Options contracts:
- Nifty 16450PE on 20th August went from 100 to 803 levels in a jiffy.
- BankNifty 37100PE on 3rd September at 10:29 AM (Low at 343.9, High at 1921.8).
- BankNifty 36000PE on 7th September at 9:15 AM (Low at 48.45, High at 750).
- BankNifty 36400CE on 8th September at 9:15 AM (Low at 196.55, High at 900).
- BankNifty 36600PE on 8th September at 9:15 AM (Low at 135.1, High at 800).
Shallow markets tend to have spikes but due to their inability to absorb large volumes in a short timespan. Some have argued that it impacts price discovery but that argument doesn't hold much water as the prices normalize immediately after the freak trades. Also, freak trades happen at certain strike prices only. It's not as though all market participants are thrown completely out of whack to such an extent that the prices are irrational for the rest of the day across all options contracts. Nevertheless, it does affect traders & it's worth highlighting & discussing Freak Trades as they happen.
Steps to avoid freak trades:
- Use Limit Orders instead of Market Orders.
- Avoid placing stop losses at obvious price levels. Usually, most pending SLs are concentrated around significant price levels. It is better to place SL orders either above or below the most obvious price.
- Use SL-L with a broad range instead of SL-M. The max limit price in an SL-L will insulate you because, entering a pre-defined order execution range, trades beyond the range will be invalidated for your pending order.
- Avoid heavily concentrated positions in one contract. Instead, trade several contracts. The likelihood of freak trades happening in multiple scrips at the same time is minimal. This will further reduce its impact on your trading portfolio; if it ever occurs.
The floor is now open for discussions 👨🏽⚖️
Hi @Tejas Khoday , First, thanks for sharing this post. I want to know how an option writer can avoid losses of freak trade who hold the positions till expiry with hedges?
The best way is to square off with limit orders. Square off the sold options first and then square off the hedges. If you square off as market orders there is a risk of freak trades happening. The risk is higher with low liquidity. So, stay away from illiquid options.
Thanks @Sujit Chakraborty , then what will happen if my sold option shot up because of freak trade, for example if I sold 36000 PE at Rs 60, and it shot up to Rs 1800 and this led to MTM loss of more than 50% of my invested amount (for few seconds), now the RMS of brokers are wired in such way that if their customer trades erode more than 50% of their invested amount then the Risk team can square off their open position without informing customer.
@Tejas Khoday
I think Fyers have to consider Freak trade situation before square off the position. I mean they have to do an adjustment in their RMS. So if the price is above some price more than few seconds and which is causing more than 50% draw down in the client position then only they should square off instead of square off the position at market price when this freak trade happens.
@Tejas Khoday please do the needful for RMS in the freak trade situation.
And I completely agree on your points.
I also think that freak trades are happening not because of Liquidity. It is happening from huge trading firms HFTs(lets consider X which is a big trading firm). Also NSE and SEBI is part of it.
NSE found guilty many time in the past. Ex colocation server case etc
Looks like when the X place huge sell/buy order at a very high/low price(illogical price) NSE is cancelling orders for a fraction of second so that X firms order get filled/executed.
Thats how more than 2 lakhs+ quantity traded at illogical price in a fraction of second.
SEBI is busy reducing margin and kick out retailers. Also banning insider traders case happened 5-10 years ago.
Even if SEBI is not part of this scam if they try to investigate they will take min of next 10 years.
All above points are my alligation backed by history and I don't have any proof.
What do you people think?
@Sumit Dey I see no reason for trades to get auto squared off by RMS if there are hedges and the risk is limited in the strategy. Freak trades can result in auto square off by RMS when not using hedges in my opinion. I don't think a defined risk strategy should have a problem. Short straddles and strangles are risky due to the unlimited loss potential and can be ruined by freak trades.
Thanks @Sujit Chakraborty , @FYERS Can you please confirm "Freak trades can result in auto square off by RMS when not using hedges in my opinion." is true or not?
@Sumit Dey - This is what I think is true unless Fyers has a freak trade detection system. Let us get more inputs from Fyers team.
@Sujit Chakraborty That's right. Hedged positions are at a lesser risk of RMS square off. However, the trouble right now is that the freak trades don't happen uniformly across all strikes and options contracts. Hence, a sharp increase in an options price could trigger RMS square off in the system even if the position is hedged. However, we are mindful of the situation and avoiding square offs if clients' have defined risk positions.
Example of how RMS square off is triggered in such situations: Let's say you you have 40k in your A/C and you entered a Bear Call spread by shorting 1 lot of BankNifty 37000CE at 50 & subsequently hedging the short exposure by buying 1 lot of 38000CE. Now, if a freak trade happens in 37000CE and the price shoots up from 50 to 2000, the notional loss on the call option will be 1950*25 = 48,750. The 38000CE wouldn't have changed at all in response to the freak trade. This will result in a margin shortfall and can trigger a system-generated RMS square-off signal. Why? Because momentarily, your account would've gone into a debit of 8750/- (Total Loss - Margin Requirement) despite having hedged your exposure completely.
To deal with this, we are evaluating positions on a case-by-case basis before initiating square-off so far.
@tejas @Sujit Chakraborty
Thank you for this. One question, how can we avoid these when we exit all the positions? Is there a chance that the positions may be squared at an unrealistic price?
@Naveen K - If you exit all positions using market order there is a risk of being a victim of a freak trade. You could be unlucky that a freak trade occurred while exiting all positions. I use limit orders only to exit positions after this freak trade crap has begun.
Thank you @Sujit Chakraborty . Can you tell me how to set limit order when entering the below example trade? Can you also show me how to exit this trade using same method if the premiums are trading at 20 Rs and 25 Rs respectively?
NIFTY 17000 PE (S) - Price 35
NIFTY 16800 PE (B) - Price 20
@Naveen K First you must place a buy limit order for NIFTY 17000 PE, check the market depth and place a limit order with the topmost quote so that it gets squared off immediately. Then immediately square off NIFTY 16800 PE by placing a sell limit order with topmost market quote so that it gets squared off immediately. If you are dealing with multiple lots make sure there is enough quantity shown in the market depth before squaring off the position. Always square off the buy order later else you may end up with margin shortfall. NIFTY options have good volumes and generally it is easy to square off.
Please take steps not to liquidate our positions due to this backend dabba traders.atleast we can save our principal.
Freak trades only last a few seconds so it's not a big area of concern right now as we are able to handle it but yes, we are mindful and will take the necessary measures to protect clients' interests to the max extent.
Hi @Tejas Khoday @FYERS We are waiting for your inputs. Do freak trades can result in auto square off, if MTM loss is greater than 80% for only few seconds?
Check my reply to @Sujit Chakraborty 's message.
Thanks @Tejas Khoday @FYERS , I had asked the same question to other brokers as well and Fyers has given the most satisfying answer so far.