Trading Mechanism

1How F&O trading works

Markets book trades in one of two ways: open outcry (members shouting and using hand signals in a trading pit) or electronic trading on screens. All F&O trading in India is electronic, on fully automated, screen-based, order-driven platforms that show bids, offers and trades continuously.

Entities:

• Trading member (TM): an exchange member trading for clients or on its own account. The exchange gives each TM a trading member ID, shared by all its users, each of whom has a unique user ID. The TM must control who can use its IDs.
• Trading cum clearing member: a TM that also clears, for itself, its clients, other TMs and custodial participants.
• Professional clearing member (PCM): clears for associated TMs and institutions but is not a TM; usually banks or custodians.
• Self clearing member (SCM): a TM that clears only its own and its clients' trades.
• Participant: a client who may trade through several TMs but settles through one clearing member.
• Authorised persons (APs): sub-brokers ceased to exist from 1 April 2019 and had to become APs or TMs.

Market hours: 9:15 a.m. to 3:30 p.m. on working days. SEBI allows exchanges to set derivatives hours anywhere between 9:00 a.m. and 11:55 p.m., if risk systems support it.

User hierarchy in the trading software:

• Corporate manager: highest level; sees all branches and dealers and is the only one who can set branch exposure limits.
• Branch manager: sees all dealers in that branch.
• Dealer: lowest level; sees only their own orders and trades.

The TM handles client compliance: KYC, the client-broker agreement, executing orders on time, collecting margins, a separate client bank account, timely pay-in and pay-out, contract notes, complaint handling, statements of account and unique client codes.

Remember

• PCM clears but does not trade. SCM clears only its own and its clients' trades.
• Only the corporate manager sets branch limits.

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2Orders, matching and operating ranges

Time conditions:

• Day order: valid only for the day; cancelled automatically at day end if not executed.
• Immediate or cancel (IOC): executes at once, fully or partly; any unmatched part is cancelled immediately.

Price conditions:

• Limit order: executes only at the stated price or better (lower for a buy, higher for a sell).
• Market order: executes at the best price available now; no price is specified.
• Stop-loss order: becomes active when a trigger price is reached, then goes into the market as a market or limit order. For a sell stop-loss, the trigger sits between the last traded price and the limit price.

Example Bought at ₹100. Place a stop-loss sell with trigger ₹95 and limit ₹92. When the price falls to ₹95, the order becomes a limit sell at ₹92.

Matching: orders are time-stamped and matched on price-time priority: best price first, and among equal prices, the earliest order. The best buy is the highest bid; the best sell is the lowest offer. Unmatched orders wait in the order books. Orders are marked Pro (proprietary) or Cli (client, with the client code).

Operating ranges: there are no daily price bands in derivatives, but to catch input errors, orders outside set ranges become a price freeze: 10% of the base price for index and stock futures, and a delta-based contract-specific range for options, updated daily.

SEBI's May 2024 rules on flexing price bands for derivative stocks:

• Flexing needs 50 trades, 10 unique traders and 3 brokers on each side (previously 25 trades and 5 traders).
• Bands move together across the cash and futures markets.
• Longer cooling-off periods: the first two flexes are 5% after 15 minutes, the next two 3% after 30 minutes, then 2% after 60 minutes.
• Bands slide: if the upper band rises (₹110 to ₹115), the lower band rises too (₹90 to ₹95).
• During a cooling-off, options get temporary price limits.

F&O instruments: index futures, index options, stock futures and stock options.

Remember

• Stop-loss = trigger price, then market or limit order.
• Matching = price first, then time.
• Futures operating range = 10% of base price.

3Which stocks qualify for derivatives

A stock must meet these tests continuously for six months:

• among the top 500 stocks by average daily market cap and traded value (rolling six months);
• median quarter-sigma order size (MQSOS) of at least ₹75 lakh;
• market-wide position limit (MWPL) of at least ₹1,500 crore;
• average daily delivery value in the cash market of at least ₹35 crore.

A stock eligible on any exchange can trade in derivatives on all exchanges.

If a stock fails these tests for three consecutive months, no new month's contracts are issued, though existing contracts trade until expiry (and new strikes can still be added). An excluded stock cannot come back for one year, and then only after meeting the criteria for six consecutive months.

Remember

• 500 stocks, MQSOS ₹75 lakh, MWPL ₹1,500 crore, delivery ₹35 crore.
• Fail for three months → no fresh contracts.

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4Product success framework for stocks

After at least six months in derivatives, a stock must also pass a product success framework (PSF) during the review period:

• at least 15% of active TMs or 200 TMs (whichever is lower) trading it on average each month;
• trading on at least 75% of trading days;
• average daily turnover (futures + options premium) of at least ₹75 crore;
• average daily notional open interest of at least ₹500 crore.

Failing stocks exit in the next review cycle (existing contracts run to expiry).

Remember

• Stock PSF: 15% / 200 TMs, 75% of days, ₹75 crore turnover, ₹500 crore OI.

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5Which indices qualify

Derivatives may be offered on an index if at least 80% of its weight is in stocks that are individually derivative-eligible, and no single ineligible stock weighs more than 5%. This is checked monthly; failing for three consecutive months stops new contracts.

The PSF for index derivatives (all except each exchange's flagship index): at least 15% of active TMs or 20 TMs trading each month, trading on 75% of days, average daily turnover ₹10 crore, average daily OI ₹4 crore. An excluded index cannot come back for at least six months, and relaunch needs SEBI approval.

A surrogate (pseudo) index lets an index that fails review keep derivatives if a similar index on another exchange qualifies. Conditions: the smaller index has at least 80% as many constituents as the larger; at least 50% of the larger index's stocks are in the smaller; and their correlation is at least 0.90 over the past six months. Only one surrogate per index per exchange.

Remember

• Index eligibility: 80% eligible weight; no ineligible stock above 5%.
• Surrogate index: 80% constituents, 50% overlap, 0.90 correlation.

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6Adjusting contracts for corporate actions

The principle: the value of every position should stay the same on the cum and ex dates, so options keep their moneyness. The exchange can adjust the strike price, the position and the market lot. Adjustments are made after trading closes on the last cum date and apply to all open positions.

Corporate actions include bonus, rights, merger or demerger, amalgamation, splits, consolidations, hive-offs, warrants, secured premium notes and extraordinary dividends.

Bonus, splits and consolidations: new strike = old strike ÷ adjustment factor; new lot = old lot × factor; new position = old position × factor.

Formula Bonus A:B → factor = (A + B) ÷ B. Split or consolidation A:B → factor = A ÷ B.

Example A 1:1 bonus gives a factor of (1 + 1) ÷ 1 = 2. A ₹1,000 strike becomes ₹500, and a lot of 250 becomes 500.

Rights: with A existing shares, B rights, last cum price P and issue price S:

Formula Benefit per share E = (P − S) ÷ (A + B); adjustment factor = (P − E) ÷ P

To avoid awkward fractions, the exchange compares position values before and after rounding the strike and lot, and settles any gap by adjusting the strike or lot, so no position is forcibly closed.

Dividends: a dividend below 2% of the share's market price is ordinary and needs no adjustment. At 2% or more it is extraordinary: the whole dividend is deducted from all option strikes from the ex-date, and futures positions are carried forward at the daily settlement price minus the dividend. The market price used is the close on the day before the board announces the dividend (or the same day if announced after market hours).

Merger or demerger: once the record date is announced, no new contracts are issued on a stock that will cease to exist. Open contracts are settled compulsorily on the last cum date at that day's closing price in the cash market.

Remember

• Strike ÷ factor; lot and position × factor.
• Dividend ≥ 2% of price = extraordinary → strikes reduced.

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7Trading costs

Three kinds:

• User charges: brokerage (often lower for intraday; many brokers now charge a flat fee per order) and exchange transaction charges (levied on both sides; on the premium for options).
• Statutory charges: STT, GST (18% on brokerage and transaction charges), stamp duty (buyers only), SEBI turnover fees (₹10 per crore plus GST) and IPFT charges (for the Investor Protection Fund Trust; NSE charges ₹10 per crore of traded value on futures and ₹50 per crore of premium on options, plus GST).
• Implicit costs: the bid-ask spread and impact cost, which no one charges but which arise from imperfect liquidity.

STT on equity derivatives from 1 April 2026 (Union Budget 2026-27):

Stamp duty: 0.002% for buyers of futures and 0.003% for buyers of options.

Example Best bid ₹16.60, best ask ₹16.80. A trader who buys at 16.80 and sells immediately at 16.60 loses ₹0.20 per unit from the spread alone. Spreads are wider in illiquid contracts.

Example Short 1 lot of index futures at 17,500 × 50 = ₹8,75,000. Brokerage at 0.03% ₹262.50, STT at 0.05% ₹437.50, exchange fees ₹17.50, SEBI and IPFT fees about ₹0.88 each, GST about ₹50.72. Total about ₹770. (Stamp duty does not apply because this is a sale.)

Remember

• STT: 0.15% on option premium (sale), 0.05% on futures (sale).
• Stamp duty is paid by buyers only.

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8Algorithmic trading

Algo trading places orders automatically using pre-programmed rules about price, timing and volume. Advantages: no emotional decisions and much faster execution. High-frequency trading is a form of algo trading with very large numbers of orders per second. It is used mainly by institutions and large brokers.

SEBI warns investors against unregulated algo platforms that promise returns. Brokers offering algos must not mention past or expected returns, and must not work with platforms that do.

SEBI's retail algo framework (from 1 October 2025):

• Up to 10 orders per second (low frequency): no registration; a generic algo ID.
• Above 10 orders per second: registration through the broker and a unique exchange algo ID.
• Open APIs are not allowed; access is through a broker-approved static IP mapped to the API key, with OAuth and mandatory two-factor authentication.
• An algo may be shared only within the family (self, spouse, dependent children and dependent parents).
• Brokers deal only with empanelled algo providers after due diligence, and handle all algo-related grievances themselves.
• A kill switch halts a malfunctioning algo.

Remember

• Above 10 orders per second → register the algo.
• Black box algo provider = registered Research Analyst.

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9Reading F&O data

Exchange websites and broker platforms show live and end-of-day data for each contract:

• Instrument: for example FUTSTK, FUTIDX, OPTSTK, OPTIDX.
• Option type: CE (call European), PE (put European), CA and PA (American).
• Corporate action level: a flag that changes on a corporate action (a symbol change or dividend).
• Open, high, low, close and last traded price.
• Open interest: for futures, open positions × last closing price of the contract; for options, open positions × the underlying's last closing price (notional value).
• Total traded quantity (contracts), total traded value and number of trades.

Trend lists: top gainers (positive trend) and losers (negative trend), OI gainers and losers (largest % change in OI), active calls and puts (highest volume), and the put-call ratio.

Remember

• CE = call European; PE = put European.

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10Protection against outages: IRRA

The Investor Risk Reduction Access (IRRA) platform is a joint exchange platform for when a broker's trading system and its disaster-recovery site are down. When the broker asks for it to be enabled, the exchanges notify investors by email or SMS and on their websites. Investors can then square off open positions and cancel pending orders, across segments and exchanges, but cannot open new positions or do anything that increases risk. The broker gets an admin terminal to monitor and act on clients' instructions. IRRA is for individual investors, not algo or institutional clients.

Remember

• IRRA: close positions and cancel orders only.

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11Technical glitches at brokers

SEBI's framework for glitches in brokers' trading systems:

• inform the exchange within 1 hour of the glitch;
• submit a preliminary incident report within T+1 days;
• submit a root cause analysis (RCA) report within 14 days, covering cause (including vendor causes), duration, chronology, impact and corrective steps;
• plan capacity for growing client numbers.

Exchanges use iSPOT (Integrated SEBI Portal for Technical Glitches) to report glitches centrally, and specified brokers connect to an API-based Logging and Monitoring Mechanism (LAMA) that monitors key system parameters.

Remember

• 1 hour to inform; T+1 preliminary report; 14 days for RCA.

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12Business continuity between exchanges

If one exchange has an outage:

• For products traded on both exchanges (common stocks, single stock derivatives, correlated indices, currency and interest rate derivatives), participants can hedge on the other exchange; because the segments are interoperable, offsetting positions net off and release margin.
• Exchanges may create reserve contracts for stocks listed only on the other exchange, to be used during its outage.
• An exchange without an index correlated to the other's may create one and list derivatives on it.
• The affected exchange must inform SEBI and the alternative venue within 75 minutes; the alternative venue invokes its plan within 15 minutes of being told.
• NSE and BSE act as each other's alternative venue, under a joint SOP.

Remember

• 75 minutes to inform; 15 minutes to invoke. NSE and BSE back each other up.

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