Sept series: What went wrong in the last 30 mins of expiry

It seems that a trading glitch occurred on Thursday (September series expiry) in the last half and hour of trade. CNBC-TV18 understands that the error relating to the 5700 Call and 6000 Put happened on the writers side in the options segment. The 5700 call closed at Rs 138.80, but with the Nifty at 5,854.55 it should have expired with a premium at Rs 180. Similarly, the 6000 Put closed at Rs 102.60, but given Nifty’s level, it should have expired with a premium at Rs 120.

The system in which options are traded is very risky and freak trades occur in this segment because options currently do not have bands and Algo trading can be another reason, says Deena Mehta, MD, Asit C Mehta Investments. This error may have happened because of two possibilities. One, there was already an order in the system at Re 1 which got hit when that market price was seen. Second, it may be Algorithmic trading because these trades are programmed in such a way that if they see opportunities at lower prices an order would be placed, she explained in an interview to CNBC-TV18.  According to her, focus on speed has led brokers to compromise on accuracy and some provisions should be made for annulment of trades. “This is a classic fight between speed and risk. If we want to go with speed, we cannot have unlimited compromise on risk, we need to have some bands,” she suggested.  She further added that market watchdog SEBI is likely to have a relook at this incident. Below is the edited transcript of Deena Mehta’s interview with CNBC-TV18 Q: We have an exchange which is very sophisticated, is this a systemic issue or is this just a sheer luck case and nothing could be done about it? A: There is an intrinsic value of the contract. If it was the Futures or the cash market there are circuit filters which stop these kinds of trades going through because the circuit will get triggered and the trade will not go through. But when it comes to Options, there are no bands within which the Option prices are operating. Because one view is that even a 1 percent change in the underlying price could lead to 70-80 percent change in the Option premium because these prices are not linear. As a result of which, the exchange has not put any band so far as the price at which the orders can be accepted by the system is concerned. Then there are two possibilities. One possibility of this trade getting executed is that there was already an order which was there in the system at Re 1 which got hit when the market price came. The second possibility is because of Algorithmic trading. These trades are so programmed that if they see opportunities at lower prices they would just put an order, which a fresh order could have come into system and somebody would have taken advantage through Algo mechanism of this error which has happened in the system. Both these possibilities are there, first possibility that people are putting orders at ridiculous prices and we need to have a thought on having bands for Option prices. This is a classic fight between speed and risk. Because you don't want to have so many checking like bands and circuits, so that would compromise on speed. In order to not compromise on speed, we have a system which is vey risky. As a result any mistake becomes absolutely uncondonable and a mistake can really ruin a person. If we want to go with speed, we cannot have unlimited compromise on risk, we need to have some bands. After all this, if we say that this is maximum that we will go to then we require very strong mechanism for annulment of contracts etc, so that people do not take advantage of such kind of situations. We have not studied the trade file but I am sure if exchange were to study the trade file it can clearly identify and even Securities and Exchange Board of India (SEBI) system can identify that there are algos which are trying to take advantage of such situations in the market. It is a very risky kind of scenario that comes out of this incident which has happened. Q: You did speak about this algo trading actually being one of the possible reasons and if in case the volumes of algo trades do increase then what are the checks and balances that could come into play or should come into play in such a situation? A: A Rs 1-2 premium can fluctuate by 100 percent like Re 1 can become Rs 2 and vise versa. At least premiums which are more than Rs 25-50, even in the premium value slab if we can introduce some kind of bands and these are very dynamic, if the price changes too much these bands can be dynamically changed. This kind of thinking coupled with a fair play in the system by having not people profiteering out of somebody’s mistake. Combination of both will be necessary to ensure that the markets are fair to everybody and people don't make undue money out of the system because. I am sure if there is no passive order lying in the system, some algo would have taken advantage. If more and more algo is going to happen, we do require checks and balances and this is going to put some overload on the system, speed will be compromised. But at the cost of having lesser risk in the system, we may compromise some speed and try to ensure that we have a fair market where small mistakes do not butcher people’s lives. Q: At the end of the day this is market dynamics, so at what point will you then introduce any kind of checks and balances? A: That is why we require dual system, one is having some kind of dynamic bands which are changed on a continuous basis. Second is having a parallel mechanism where you can clearly identify that somebody is taking the benefit of the situation and somebody out of greed is trying to cash out on somebody’s mistakes. These kind of things have to be stopped. If you require any manual system it has to be introduced because ultimately what are markets about - the markets are about giving fair prices, markets are about price discovery. If the intrinsic value of a contract is Rs 200 you cannot have it trading at Re 1 or Rs 21.