The ‘freak show’ on the NSE and why it is happening

On Tuesday, the Indian stock markets were witness to a ‘freak show’ that saw futures contracts of several index heavyweights on the National Stock Exchange (NSE) open with a gap up of as much as 10%.

As stock markets opened for trade, September futures of several marquee counters including Reliance Industries Ltd (RIL), HDFC Bank, HDFC Ltd and Bharti Airtel were up sharply. 

While RIL futures opened with a 9% spike over the previous close, futures of Bharti Airtel and the HDFC twins were up by nearly 10% each. This, even as these counters were trading flat on the spot market. 

So, effectively, even while there was no significant movement in the underlying stocks, the derivatives market opened with a significant gap up.

Has such freak trade happened before?

Yes, this is not the first time such a ‘freak show’ has happened on the India share bazaar. Exactly a week before the latest anomalous event, movement in the Bank Nifty options segment had given a nervous time to traders as the index surged by a staggering 2,000%. 

The premium of weekly Bank Nifty 36,000-strike put option, due for expiry on September 9, surged to a high of Rs 750 from Rs 35.25. It finally closed at Rs 53.65 against the previous close of Rs 62.15. The underlying Bank Nifty index opened at 36,559 points and hit a high of 36,686 before closing with a loss of over 100 points. 

In fact, these events have been happening ever since the NSE scrapped the so-called trade execution range (TER) in August. The TER had been put in place to avoid erroneous trades, colloquially dubbed ‘fat finger trades’.

What is the trade execution range? What are fat finger trades?

Trade execution range (TER) basically refers to a quantity freeze rule that regulates the order flow to within a range, so as to avoid erroneous trades caused by mistyping. 

A ‘fat finger trade’ is one where the number of units of say an index or stock futures to be bought or sold are entered erroneously. This triggers a massive upsurge in demand or supply, leading to a significant gap up or gap down opening.

In August, the exchange had defined these freeze quantities for Nifty, Bank Nifty, Finnifty at 2800, 1200, and 2800, respectively. Above these limits, orders would be automatically cancelled. 

Moreover, the NSE had also set price ranges. If the price crossed the lower or upper limits, the exchange would halt any trading till the price came down. 

So, why was this system abolished? Why is that a problem now?

The new system became problematic and caused price discovery distortions when prices actually swung sharply, causing a mismatch. So, the NSE removed it. 

But the removal of the system has now become problematic as it has led to these freak trades. 

A Moneycontrol report says this is also thanks to people trying to game the system, in a bid to avoid taxes. 
The report points out that while the cash segments have various price filters, the F&O segment does not have such filters. “However, there is a dynamic price band of 10% on either side. When the prices of the futures contract hit the 10% limit, there is a cooling period of 15 minutes before the limits are revised for the day,” it notes.

According to the report, high-net-worth individuals looking to evade tax or launder undisclosed income often do so through fictitious trades in the F&O segment. “There are brokers who offer such services for a fee,” it added. 

Since law enforcement authorities like the income tax department and the market regulator, the Securities and Exchange Board of India (SEBI), have tried to curb this activity in the F&O segment, the action seems to have shifted to index heavyweight stocks.