TRADING MECHANISM

Trading Mechanism

Definition: The trading mechanism refers to the process by which buyers and sellers interact to buy and sell securities, including futures and options, on an exchange.
Details: The trading mechanism can be classified into two main types: open outcry and electronic. In an open outcry market, trading takes place in a large hall known as a "pit" where members are present and contracts are traded through continuous bids and offers. In an electronic market, trading takes place through screen-based broker dealing terminals.

Entities Involved in Trading

Trading Member: A member of a stock exchange who can trade either on behalf of their clients or on their own account.
Trading cum Clearing Member: A clearing member who is also a trading member of the exchange.
Professional Clearing Member: A clearing member who clears the trades of their associate trading members and institutional clients.
Self Clearing Member: A self-clearing member who is also a trading member on the exchange and can clear and settle only their own proprietary trades and their clients' trades.
Participants: Clients of a trading member who can trade through various trading members but settle through a single clearing member.
Authorised Persons: Individuals who are authorized to act on behalf of a trading member.

Market Timing of Derivative Segment

Trading Hours: Trading on the derivatives segment takes place on all working days of the week between 9:15 am and 3:30 pm.
SEBI Regulations: SEBI has permitted stock exchanges to set their trading hours in the Equity Derivatives Segment between 9:00 AM and 11:55 PM, provided that the stock exchange and its clearing corporation have in place a risk management system and infrastructure commensurate to the trading hours.

Corporate Hierarchy

Corporate Manager: The highest level in a trading firm who can perform all functions, including order and trade-related activities, receiving reports for all branches of the trading member firm, and defining exposure limits for the branches of the firm.
Branch Manager: A user who is placed under the corporate manager and can perform and view order and trade-related activities for all dealers under that branch.
Dealer: The lowest level of the user hierarchy who can only view their own orders and trades and does not have access to information on other dealers under either the same branch or in other branches.

Client Broker Relationship

Trading Member Responsibilities: A trading member is responsible for various compliance-related activities, including Know Your Client (KYC) form, execution of Client Broker agreement, timely execution of orders given by clients, collection of adequate margins, maintaining separate client bank accounts for segregation of client money, ensuring timely pay-in and pay-out of funds, timely issue of contract notes, resolving clients' complaints, sending periodical statements of accounts, and maintaining unique client codes.

Order Types and Conditions

Time Conditions: Day order, Immediate or Cancel (IOC) order.
Price Conditions: Limit order, Market order, Stop-loss order.
Order Matching Rules: Orders match automatically on a price-time priority basis.

Price Band

Definition: A price band is a range of prices within which a security can trade.
Details: There are no price bands applicable in the derivatives segment, but operating ranges and day minimum/maximum ranges are kept to prevent erroneous order entry.

The Trader Workstation

Market Watch Window: A window that displays real-time market data, including prices, volumes, and order books.
Order/Trade Window: A window where traders can enter orders and view their trade history.
System Message Window: A window that displays system messages, including trade confirmations and error messages.

Futures and Options Market Instruments

Index-Based Futures: Futures contracts based on a stock index, such as the Nifty or Sensex.
Index-Based Options: Options contracts based on a stock index, such as the Nifty or Sensex.
Individual Stock Options: Options contracts based on individual stocks.
Individual Stock Futures: Futures contracts based on individual stocks.

Eligibility Criteria for Selection of Stocks for Derivatives Trading

Introduction: The stock selection criteria for derivatives trading in India ensure that the stock is large in terms of market capitalization, turnover, and has sufficient liquidity in the underlying market, with no adverse issues related to market manipulation.
Eligibility Criteria: A stock must conform to the following broad eligibility criteria for a continuous period of six months:
- The stock shall be chosen from amongst the top 500 stocks in terms of average daily market capitalization and average daily traded value in the previous six months on a rolling basis.
- The stock’s median quarter-sigma order size (MQSOS) over the last six months, on a rolling basis, shall not be less than Rs 75 Lakhs.
- The market wide position limit (MWPL) in the stock shall not be less than Rs 1500 crores on a rolling basis.
- Average daily delivery value in the cash market shall not be less than Rs 35 crores in the previous six months on a rolling basis.
Exit Norms: If an existing security fails to meet the continued eligibility criteria for three months consecutively, then no fresh month contract shall be issued on that security. However, the existing unexpired contracts may be permitted to trade till expiry and new strikes may also be introduced in the existing contract months.
Product Success Framework (PSF): Additional exit criteria for stocks from the derivatives segment include:
- At least 15% of trading members active in all stock derivatives or 200 trading members, whichever is lower, shall have traded in any derivative contract on the stock being reviewed on an average on a monthly basis during the review period.
- Trading on a minimum of 75% of the trading days during the review period.
- Average daily turnover single-sided (futures + options premium) of at least INR 75 crores during the review period.
- Average daily notional open interest single-sided (futures + options notional) of at least INR 500 crores during the review period.
Re-introduction of Excluded Stocks: A stock which is excluded from derivatives trading may become eligible once again if it fulfills the eligibility criteria for six consecutive months.

Selection Criteria of Index for Trading

Eligibility Criteria: The exchange considers introducing derivative contracts on an index if the weightage of constituent stocks eligible for derivatives trading is at least 80%. No single ineligible stock should have a weightage of more than 5%.
Continuous Compliance: The index must comply with eligibility criteria on a continuous basis, with the exchange checking compliance monthly. If the index fails to meet criteria for three consecutive months, no fresh contracts will be issued.
Product Success Framework: Applies to all index derivatives (except flagship indices) at the underlying level, with criteria including:
- 15% of trading members active in all index derivatives or 20 trading members should have traded in the derivative contract.
- Trading on at least 75% of trading days during the review period.
- Average daily turnover of at least INR 10 crore.
- Average daily open interest of INR 4 crore.
Re-inclusion: An excluded index cannot be considered for re-inclusion for at least six months, but may be re-launched after modifications and SEBI approval.

Surrogate/Pseudo Index

Definition: An alternative index used when the primary index doesn't meet derivatives trading criteria, but a similar index on another exchange does.
Purpose: Allows derivatives on an index that fails review if a surrogate index meets necessary criteria.
Conditions:
- The smaller index should have at least 80% of the constituents of the larger index.
- At least 50% of the larger index's constituent stocks should be part of the smaller index.
- Correlation between the two indices should be at least 0.90 for the previous 6 months.
Limitation: An index can have only one pseudo/surrogate index per exchange.

Adjustments for Corporate Actions

Definition: Adjustments for corporate actions are modifications to positions and/or contract specifications to ensure the value of market participants' positions remains the same after a corporate action.
Details: These adjustments are made to retain the relative status of positions (in-the-money, at-the-money, and out-of-money) and address issues related to exercise and assignments.

Types of Corporate Actions

Stock Benefits: Include bonus, rights, merger/demerger, amalgamation, splits, consolidations, hive-off, and warrants.
Cash Benefits: Include extraordinary dividends and secured premium notes (SPNs).

Adjustment Factors

Bonus: Adjustment factor = (A+B)/B, where A:B is the bonus ratio.
Stock Splits and Consolidations: Adjustment factor = A/B, where A:B is the split or consolidation ratio.
Rights: Adjustment factor = (P-E)/P, where P is the underlying close price, E is the benefit per share, and P-E is the benefit per right entitlement.

Adjustment Methodology

Strike Price: New strike price = old strike price / adjustment factor.
Market Lot/Multiplier: New market lot/multiplier = old market lot * adjustment factor.
Position: New position = old position * adjustment factor.

Dividends

Ordinary Dividends: No adjustment in strike price for dividends below 2% of the market value of the underlying stock.
Extra-Ordinary Dividends: Strike price adjusted for dividends above 2% of the market value of the underlying stock.
Adjustment: All positions in existing strike prices continue to exist in corresponding new adjusted strike prices for respective option contracts.

Merger/Demerger

Last Cum-Date: Determined by the Exchange/Clearing Corporation on announcement of the record date for merger/demerger.
Contract Expiration: All contracts in the underlying that shall cease to exist subsequent to the merger/demerger expire on the last cum-date.
Settlement: Un-expired contracts outstanding as on the last cum-date are compulsorily settled at the settlement price, which is the last available closing price of the underlying in the Capital Market segment of the Exchanges on the last cum-date.

3. Trading costs

Definition: Trading costs are expenses incurred by a participant in the equity derivatives market, which can be broadly classified into user charges, statutory charges, and impact cost.
Details:
- User charges include brokerage, which is the commission charged by brokers for placing orders, and transaction charges, which are fees levied by stock exchanges on trades.
- Statutory charges include:
  - Securities Transaction Tax (STT): 0.10% to 0.125% on option premiums and 0.02% on futures prices
  - Goods and Services Tax (GST): 18% on brokerage and transaction charges
  - Stamp Duty: 0.002% to 0.003% on equity futures and options
  - SEBI Turnover fees: Rs. 10 per crore plus applicable GST
  - IPFT Charges: fees levied by stock exchanges to fund investor protection and education
- Impact cost is a measure of the cost incurred due to the bid-ask spread, which is the difference between the best buy and sell prices.
- Bid-ask spread tends to be larger for illiquid stocks and can result in higher impact costs for traders.
- Example: The total trading cost for a short position of 1 lot of index futures can include brokerage, STT, exchange fees, SEBI charges, IPFT charges, and GST, totaling Rs. 507.47.

Algorithmic Trading

Definition: Algorithmic trading is a process of executing orders utilizing automated and pre-programmed trading instructions to account for variables such as price, timing, and volume.
Details: It uses a mathematical model developed by programmers, considering changing market conditions, to dynamically place buy and sell orders in the market.

Key Benefits

Emotionless Trading: Algorithmic trading eliminates the impact of individual trader emotions on trading decisions.
Speed: It reduces the overall time taken for order execution, as computers can place orders at higher speeds than human operators.

Regulatory Framework

SEBI Guidelines: SEBI has cautioned investors against dealing with unregulated platforms offering algorithmic trading services and has introduced measures to strengthen controls around algo trading.
Key Terms:
- API (Application Programming Interface): A set of rules and protocols for software applications to communicate and exchange data.
- Static IP: A fixed IP address approved by the broker to avoid unauthorized access.
- OAuth (Open Authentication): A secure authorization framework for third-party applications to access user data without requiring login credentials.
- 2FA (Two Factor Authentication): Any user accessing API must have two layers of verification.
- Algo ID: A unique identifier assigned to each registered algo for surveillance purposes.
- Kill Switch: An emergency function to automatically halt trading activity based on pre-defined conditions.

Algo Categorization

Execution Algos (White Box): Logic is disclosed to the user, replicable, and transparent.
Black Box Algos: Logic is not known to the user, not replicable, and lacks transparency.

Regulatory Proposals (Effective Oct 01, 2025)

Orders per Second (OPS):
- Low Frequency Algo (≤ 10 OPS): Registration not required, generic Algo ID.
- High Frequency Algo (> 10 OPS): Registration mandatory via broker, unique exchange ID.
User Eligibility: Allowed to share within family with 2FA verification.
API Access:
- Open APIs not allowed.
- Mapped to broker-approved Static IP and API key.
- Multiple API keys allowed for segregating registered or unregistered algos.
Security: OAuth permitted only, mandatory 2FA.
Brokers’ Role: Deal with empaneled algo providers only, due diligence before empanelment, and responsibilities of surveillance.

Tracking Futures and Options Data

Introduction: Prior to the rise of internet trading, daily newspapers were the primary source of information for spot and derivatives prices. Now, prices and other details can be tracked in real-time on exchange websites and online trading platforms.
Trackable Details:
- Date: The trade date.
- Symbol: The underlying index or stock (e.g., NIFTY, ACC).
- Instrument: The contract descriptor for derivatives segment instruments (e.g., FUTSTK, OPTIDX).
- Expiry Date: The date on which the contract expires.
- Option Type: The type of option for the contract (CE - Call European, PE - Put European, CA - Call American, PA - Put American).
- Corporate Action Level: The Corporate Action Flag, which changes with corporate actions like symbol changes or dividend announcements.
- Strike Price: The strike price of the contract.
- Price Movements:
  - Opening Price: The price at which the contract opened for the day.
  - High Price: The highest price at which the contract was traded during the day.
  - Low Price: The lowest price at which the contract was traded during the day.
  - Closing Price: The price of the contract at the end of the day.
  - Last Traded Price: The price at which the last contract of the day was traded.
- Open Interest: For futures contracts, it's the open positions multiplied by the last available closing price. For option contracts, it's the open positions multiplied by the notional value.
- Trading Activity:
  - Total Traded Quantity: The total number of contracts traded during the day.
  - Total Traded Value: The total money value of the business that took place on the contract during the day.
  - Number of Trades: The total number of trades that took place on the instrument during the day.
Trend Information:
- Positive Trend: Information about the top gainers in the futures market.
- Negative Trend: Information about the top losers in the futures market.
- Futures OI Gainers/Losers: Lists futures with the highest % increase/decrease in Open Interest.
- Active Calls/Puts: Calls/Puts with high trading volumes on that particular day.
- Put/Call Ratio (PCR): The ratio of trading volume of put options to call options, calculated based on options trading volumes or open interest.

Introduction of Investor Risk Reduction Access (IRRA) platform

Definition: The IRRA platform is designed to protect investors from technical glitches and unforeseen outages that can make a trading member's site inaccessible.
Details: It provides an alternative when both the primary trading platform and the disaster recovery sites are experiencing challenges.

Key Features of IRRA platform

Joint Platform: Developed by exchanges to provide investors an opportunity to square off/close open positions and/or cancel pending orders in case of disruption of trading services.
Multi-Segment Support: Supports multiple segments across multiple exchanges.
Enablement: Trading Members (TMs) can request enablement of IRRA service in case of technical glitches, and it will be enabled upon receipt of such requests.
Investor Notification: Investors will be informed about the availability of IRRA service through email/SMS and a public notice on exchanges' websites.
Usage: Investors can use IRRA to square off/close open positions and/or cancel pending orders, but it does not permit actions that increase the risk of the investor.
Admin Terminal: Provides TMs with access to an Admin Terminal to monitor investor actions and carry out actions on instructions of investors.

Framework to Address Technical Glitches

Immediate Notification: Stock brokers must inform exchanges about technical glitches immediately, but not later than 1 hour from the time of occurrence.
Preliminary Incident Report: Stock brokers must submit a Preliminary Incident Report to the Exchange within T+1 day of the incident.
Root Cause Analysis (RCA) Report: Stock brokers must submit an RCA Report to the stock exchange within 14 days from the date of the incident.
Capacity Planning: Stock brokers must have adequate capacity planning to provide continuity of services to their clients.
Integrated SEBI Portal for Technical Glitches (iSPOT): A web-based portal for submission of preliminary and final RCA reports of technical glitches.

Business Continuity for Interoperable Segments of Stock Exchanges

Common Scrips and Derivatives: If identical or correlated trading products are available on another trading venue, participants can hedge their open positions by taking offsetting positions.
Scrips Exclusively Listed on an Exchange: Exchanges may create reserve contracts for scrips exclusively listed on other exchanges to ensure continuity.
Index Derivatives Products: Exchanges may consider creating index derivatives products not having correlated index derivatives products on another exchange.
Intimation to SEBI and Alternative Trading Venue: The affected exchange must comply with regulatory requirements and intimate about the invocation of the business continuity mechanism to the alternative trading venue and SEBI within 75 minutes of occurrence.