The increasingly frequent abrupt spikes in option premiums has spurred calls for imposing limits on option price movements or tightening an existing framework. Such spikes are now occurring as frequently as four to five times a month, against probably once in a year earlier, posing challenges for traders.
Traders are concerned that HFT players’ algorithmic trading is behind these frequent spikes, and are thus calling for putting in place protection mechanisms. “I hope NSE finds a way to tackle these unusual occurrences, so that expiry traders can trade without the fear of their options suddenly increasing 10x or 50x in a matter of seconds,” said derivatives trader Sarang Sood.
Recalling notable option spikes from the last month
On April 23, put options for FinNifty across various strikes, ranging from 20,700 to 21,400, experienced a dramatic surge in the afternoon, escalating by up to 20 times in just one minute. Interestingly, the underlying FinNifty index saw a minor decline of less than 50 points during the same period.
On April 18, the premium of Nifty 50 out-of-the-money put options at 22300 skyrocketed from Rs 39.65 to Rs 250 within a single minute, later peaking at Rs 392.25.
Another instance occurred on April 8, when the price of Midcap Nifty 10,800 put options surged from Rs 0.85 to approximately Rs 150 within a mere 3 minutes, between 1:30 and 2:30 in the afternoon. This spike followed sharp weakness in the index, prompting frantic exits by put-call writers and subsequent short-covering rallies.
Also read: Sudden surge in FinNifty put options raise alarms, premiums spike up to 20x in a minute
What is causing the abrupt spikes in option prices?
Potential reasons attributed to these spikes include the involvement of high-frequency trading (HFT) firms using algorithmic trading strategies, occurrences of fat-finger errors, and the regular expirations of lesser-liquid indexes like FinNifty and MidcapNifty, which are susceptible to manipulation through movements in underlying stocks.
According to traders, significant market operators with substantial market exposure may be executing basket orders in stocks, subsequently affecting derivatives traders by triggering their stop losses.
Should NSE revisit option spike limit norms?
“Previously, there used to be a limit to option spikes which NSE removed in 2021. For example, an option could only go up by Rs 20-30 in seconds. Then if that happened, the option would freeze and then reopen. This would prevent such abnormal spikes on counters,” said Sarang Sood.
On the other hand, derivatives trader Santosh Pasi calls for making the National Stock Exchange’s existing Limit Price Protection (LPP) mechanism more robust by removing an exception.
Under the Limit Price Protection Mechanism (LPP), option contracts with instrument prices below Rs 50 may fluctuate within an absolute range of Rs 20, while contracts above Rs 50 are limited to a maximum movement of 40 percent. “When the price of an order is placed outside the mentioned range, the system automatically rejects it,” Pasi said.
However, an exception to this rule allows the limit to be flexed when 10 orders are rejected from at least 5 unique clients and at least 3 unique trading members. “It seems some groups are exploiting this exception (criteria for relaxation) and are triggering these spikes,” Pasi added.
Pasi called for the exchange to either remove this exception completely or add more conditions such as rejection of orders from 50 unique client codes (UCCs) instead of 5.
How worrisome is the option prices spike
Derivatives trader Shijumon Anthony said that occasional spikes are not a new thing. “Earlier it was not that impactful because there used to be only one weekly expiry. Now we have at least one index expiring every day of the week, with most traders focusing on the expiry day trades. So every spike is impacting the traders,” he said.
Since the root cause and the initial trigger of the spike is the sudden sharp movement in the underlying index, Anthony suggests that the exchange can bring in some limit for shares per order in the cash market too. “We have that limit only in the FnO (futures and options) market, which doesn’t arrest the root cause.”
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