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: 

  1. Lack of liquidity as there are many options contracts for each F&O stock/index.
  2. Stop Loss Triggering can be either incidental or caused by SL hunting by HFTs.
  3. Fat finger trades can happen. I'll post more about this soon.
  4. Panic square off can happen but usually on big market moves or event days.
  5. 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:

  1. Use Limit Orders instead of Market Orders.
  2. 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.
  3. 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. 
  4. 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 👨🏽‍⚖️