LIMIT PRICE PROTECTION

To maintain orderly trading, efficient risk management, and price discovery, the exchange has a strong framework for managing risk. It also regularly examines and puts into effect various pre-trade risk control procedures. The Exchange is implementing the Limit Price Protection (LPP) scheme to significantly strengthen the pre-trade risk control methods for preventing anomalous orders and ensuring orderly trading.

Background

Many traders face huge losses due to freak trades. This concern was partially addressed by discontinuing the stop loss market (SL-M) for option contracts (both index and single-stock).

A freak trade is a faulty trade that occurs when the price suddenly rises and falls in a matter of seconds. It is triggered when a huge buy or sell order is placed erroneously at a price well outside the range of the market, triggering the investors’ pre-set stop-loss.

A live example of freak trade would be: a trader sold 1.25 million units of Nifty 50 index at ₹0.15 per unit for 14,500 call options instead of 16,500 call options. On that day Nifty 50 indies hit a high of ₹2,139.85 and a low of ₹0.15.

As a consequence of removing SL-M order, there was great downside exposure. To protect orders from significant price movements and freak trades, NSE introduced Limit Price Protection (LPP).

Basics of LPP Norms

Limit Price Protection is a function that protects your open orders against significant market changes and unusual trading activity. The Limit Price Protection mechanism, for example, will prevent stop-loss or take-profit orders from being activated when the Last Price and the Market Price of an options contract reaches a pre-determined threshold.

To implement LPP, NSE adheres to a set of rules. Some crucial points are listed below.

• LPP mechanism is only applicable on stock option, and index option limit orders. Market orders are executed directly without going through LPP norms.
• To validate the price of limit orders, the LPP range must be the range on each side of the reference price.
• Each contract's reference price should be determined using the formulas below:

*For first 30 seconds or at market opening reference price shall be computed theoretically using underlying price as discovered in the cash market pre-open session, benchmark interest rate as MIBOR rate (for option contracts, Black Scholes model shall be used along with appropriate volatility).

*Contract’s base price: the average market price of the group of underlying securities at a specific time

• The Exchange must automatically reject any receiving Limit order placed outside of the LPP range as follows:

-> Buy order price > High LPP limit

-> Sell order price < Low LPP limit

• The following formula should be used to calculate the LPP range on both sides of the reference price:

Examples

1)  If current market price of Nifty 18000 CE is ₹45 so LLP range will be on lower side ₹25 & higher side ₹65 as we add & subtract ₹20 from CMP.

a)  If you buy the options at ₹45 & set stop loss at ₹40 and limit price at ₹35. If options price will fall below ₹40 then your position will get squared off between ₹40 to ₹35 at best available price in market.

b)  If you buy the options at ₹45 & set stop loss at ₹35 and limit price at ₹24. If options price will fall below ₹40 then your order will get rejected by exchange as stop loss limit price is out of range of LPP.

c)  If you buy stoploss above ₹55 & set limit price at ₹60. If options price will rise above ₹55 then your order will get executed between ₹55 to ₹60 at best available price in market.

d)  If you buy stoploss above ₹55 & set limit price at ₹66. If options price will rise above ₹55 then your order will get rejected by exchange as stop loss limit price is out of range of LPP.

e)  If you sell stoploss below ₹42 & set limit price at ₹38. If options price will fall below ₹42 then your order will get executed between ₹42 to ₹38 at best available price in market.

f)  If you sell stoploss below ₹30 & set limit price at ₹20. If options price will fall below ₹30 then your order will get rejected by exchange as stop loss limit price is out of range of LPP.

2)  If current market price of Bank Nifty 38000 CE is ₹1000 so LLP range will be on lower side ₹600 & higher side ₹1400 as we add & subtract 40% from CMP.

g)  If you buy the options at ₹1000 & set stop loss at ₹900 and limit price at ₹850. If options price will fall below ₹900 then your position will get squared off between ₹900 to ₹850 at best available price in market.

h)  If you buy the options at ₹1000 & set stop loss at ₹800 and limit price at ₹590. If options price will fall below 800 then your order will get rejected by exchange as stop loss limit price is out of range of LPP.

i)  If you buy stoploss above s. 1000 & set limit price at ₹1100. If options price will rise above ₹1100 then your order will get executed between ₹1000 to ₹1100 at best available price in market.

j)  If you buy stoploss above ₹1300 & set limit price at ₹1450. If options price will rise above ₹1300 then your order will get rejected by exchange as stop loss limit price is out of range of LPP.

k) If you sell with stoploss below ₹900 & limit price at ₹850. If options price will fall below ₹900 then your order will get executed between ₹900 to ₹850 at best available price in market.

l)  If you sell with stoploss below ₹700 & limit price at ₹550. If options price will fall below ₹700 then your order will get rejected by exchange as stop loss limit price is out of range of LPP.

Flow Chart:

Follow the flowchart presented below to get a better understanding of how the LPP mechanism works.

Conclusion

In order to prevent unusual orders and ensure fair trading, the Limit Price Protection (LPP) scheme greatly increases the pre-trade risk control mechanisms. The exchange rejects those orders which does not follow the LPP range.

Q&A

Q1.  Is LPP facility offered by ICICIdirect?

Ans-  Yes. The LPP facility is offered by ICICIdirect efficient and effectively to manage risk of clients.

Q2.  How is LPP calculated in ICICIdirect?

Ans-  As the exchange has directed, the following formula should be used to calculate the LPP range on both sides of the reference price:

Q3.  What will be the consequences if a client places order or stop loss out of LPP range?

Ans-  The order will get rejected by the exchange and thus won’t get executed. It is suggested to place order in LPP range for better execution.

Q4. What actions will ICICI Securities take if LPP gets rejected by the exchange?

Ans- Your order book will show the reject status in the trading account. You will have to place the order again.

Q5. Does LPP have any impact on OptionsPlus position?

Ans- In case stoploss is out of LPP range, NSE rejects the order. ICICIdirect system will square off the position immediately afterwards.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The securities quoted are exemplary and are not recommendatory. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose. The information mentioned herein above is only for consumption by the client and such material should not be redistributed. 

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