SEBI recently revised the flexing rules for price (operating) bands on stocks on which futures and options (F&O) are traded. This week, we discuss whether the revised rules impact your trading strategies.
Flexing bands
The default price band on stocks on which F&O are unavailable is 20 per cent. So, a stock’s trading range for a day is plus or minus 20 per cent of its previous day’s closing price. If a stock were to hit the upper price band, the stock would have numerous buy orders and often no sell orders. The sellers would withdraw their orders in anticipation of the stock rising further the next day. The same is true if a stock were to hit the lower price band; the stock would have more sell orders and often no buy orders.
Stock on which F&O are traded have a flexing band. The band starts at 10 per cent of the previous day’s closing price. The band is then revised intraday to let the stock and its futures contract trade at a higher or lower price based on some rules. This is called flexing the band, which makes it different from price bands on other stocks.
Suffice it to understand that SEBI has now revised the rules for flexing. The objective is to control a sharp price increase or decline on a stock or its futures contract during a day. Chambal Fertilizers, for instance, moved up 20 per cent on June 20, as NSE flexed the price band. The change in rules will henceforth make such price movement gradual. It is moot if the price change of 20 per cent or more in one day is risky than if the same were to happen over, say, two-three days. It is more important to have counterparties to exit your position, whether the price moves sharply or at a controlled pace.
That said, the revision is unlikely to significantly affect your trading strategies. Your futures positions are setup to ride price momentum. Not all momentum trades are likely to see flexing of price bands. Also, you are likely to use options to bet on time decay when stocks are expected to move sideways. Of course, it is possible that a futures contract attracts band flexing after your position is open. If the price moves in the same direction as your position, the revised flexing rules will give you time to decide whether to close the trade or continue with the position. If the flexing were to happen in the opposite direction, cutting your losses may be delayed.
Optional reading
Price band is meant to slow the movement of futures contract and its underlying price. Traders are likely to adjust to revised rules over time. For instance, scalping trades were popular before securities transaction tax (STT) and other additional charges were levied. Now, traders continue to scalp, having adjusted over time to the higher transaction costs.
The author offers training programmes for individuals to manage their personal investments