What is an F&O ban? How does it impact stock prices?

The futures and options (F&O) contract of any stock can be put under a ban to prevent heightened speculation activity. Typically, a ban, which is a restriction, is put in place when the total open interest, or OI, of a stock, crosses 95 per cent of the market-wide position limit (MWPL).

For the unversed, open interest is the total number of future contracts held by market participants at the end of the day. It is used as an indicator to figure out market sentiment and the strength behind price trends.

While MWPL is a trading limit for any F&O contract for security, the limit is indeed decided by the stock exchange and is suggestive of the maximum number of contracts that can be opened at a particular point in time.

Importantly, for the stocks placed under the F&O ban, while you can square off your existing position, you cannot open a new position.

Nonetheless, due to the ban on the F&O contracts of the securities, the cash segment is not impacted.

As per the NSE website, at the end of each day, the exchange disseminates the aggregate open interest across all exchanges in the futures and options on individual scrips along with the market-wide position limit for that scrip and tests whether the aggregate open interest for any scrip exceeds 95 per cent of the market-wide position limit for that scrip. 

If yes, the exchange takes note of the open positions of all clients/ trading members (TMs) at the end of that day in that scrip, and from the next day onwards, the clients/ TMs should trade only to decrease their positions through offsetting positions until normal trading in the scrip is resumed.

Normal trading in the scrip is resumed only after the aggregate open interest across exchanges comes down to 80 per cent or below the market-wide position limit.

"A facility is available on the trading system to display an alert once the open interest on the NSE in the futures and options contract in a security exceeds 60 per cent of the market-wide position limit specified for such a security. Such alerts are presently displayed at time intervals of 10 minutes," added the stock exchange's website.

How long is the ban period on NSE?

The ban, which is put in place once the 95 per cent MWPL is reached, is in force until the OI comes below 80 per cent of the MWPL. The systems prompt clients at 80 per cent, 85 per cent and 90 per cent so that they can act accordingly.

Repercussions in case the broker allows open positions in such derivative contracts under the ban

If the broker allows holding fresh positions in F&O contracts for such stocks, a penalty will be charged for violating the regulations. The idea is primarily to curb speculation in stocks with low floats.

Impact on stock price 

The F&O contracts of each of the stocks for which a ban is in place witness a constant correction in price. Further, the prices also see a downward move as investors, after the ban is imposed, are required to square off their positions and hence cut down their profits on the trades.