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How to Set Stop Loss Limit Order in Options? Why NSE Banned Stop Loss Market Order for Options Trading?

NSE Ban on Stop Loss Market Orders for Options From 27th Sept 2021

Investment and Trading in the stock market have changed the fortune of many people around the world over the period of time. We have seen examples of great investors like Mr. Warren Buffett and some of the biggest traders like Mr. Jim Simons, and many stock market participants are inspired by industry legends like them. Unfortunately, due to a lack of proper knowledge and discipline in the trading and investment journey, quite a large number of stock market participants have lost their money in the market.

The Stock market in India is a highly regulated industry that follows strict rules and regulations, set up by the regulator of the market SEBI, for the protection of stock market participants. India has been witnessing a significant increase in the number of secondary market participants in recent years, and as our market matures and develops, Exchanges and SEBI formulate new rules, guidelines, and practices for the protection of the Stock Market participants, especially retailers.

Earlier there were adaptive circuit filters on Option Premium, which gets adjusted as the LTP of Option Premium hit the Circuit Filter. The readjustment of the Circuit limits had a slight delay and by the time the Premium would have drastically changed, which resulted in significant loss to traders. To avoid this the exchanges removed the circuit filter on option premium and allowed trading throughout the trading range. Freak traders made use of this situation and hunted the stop loss of all those who had kept Stop Loss-Market orders, resulting in significant loss to the traders. You can read the detailed article about Freak Trades in our article Freak Trade.

Stop Loss Market Order and Risks Involved

Stop Loss Market orders are widely used in the stock market, without traders actually knowing the significant downfall such orders have. When Placing an SL-Market order, you are giving consent to the exchange to execute your order at the next available market price when your order gets active in the Exchange. In the majority of cases, the next available Market price would be close to your Order price, if sufficient liquidity is available, so it gets executed with a minor slippage and goes unnoticed often.

But there is a potential threat in SL-Market Orders if the next available trade price is far away from your Stop Loss price, in low liquidity stocks and far OTM or ITM Options you could see the significant difference in the Bid-Ask Spread prices. In such cases, if you have placed an SL-Market order it would be executed at a far away price based on liquidity and you would incur a significant loss without even knowing what went wrong in the trade.

We have seen the Call Option premium of Nifty Aug 16450 CE moving from 80/- Rs to 800/- Rs in a second, whipping out a significant amount from all those who have kept SL-Market order on 20-Aug-2021 in a Freak Trade. To avoid such kinds of Freak trades up to an extent, NSE is banning Stop Loss Market Orders for Options from 27th September 2021. Thereafter only Stop Loss Limit Order is there in the market, SL-Limit orders can protect you from scenarios like Freak Trade and at the same time serves its function of Stop Loss.

You should carefully set the Trigger and Limit Prices in an SL-Limit order to ensure its proper execution, even in a highly volatile market. One drawback of SL-Limit orders is that in a highly volatile market condition the order doesn’t get executed when the Trigger and Limit Prices are kept too close. So always wisely set Trigger and Limit Prices in an SL-Limit Order.

How to Use SL-Limit orders effectively 

  1. When you take Short Position

Suppose if you are shorting the market, you could place an SL-Limit order with your Trigger Price Less than the Limit Price. 

Eg: You have a Bearish view on Axis Bank, and Selling Axis Bank @ 800/- Rs and with a risk appetite of maximum Rs. 20/- share. So you keep a Stop Loss Limit Order with Buy Price 820/- and Trigger Price of 815/-

You short Axis Bank with a view that it will be bearish, and placed a Stop Loss Limit order with a Trigger price of 815/- and Limit Price of 820/-. If the Market reverses and Axis Bank price reaches 815/- then your limit Stop Loss Limit order of 820/- will become active in the Exchange. Since the Buy Price of 820/- is higher than the LTP of 815/-, the order gets executed as similar as a Market order at the next available price, let’s say at 816/-. Your order can get executed within the range of 815/- to 820/- depending on the LTP at the very next moment your order gets active in exchange. 

If a Freak trade occurs and shoots the price from 800/- to 2000/-, you are protected since you placed an SL-Limit order, as your order will only get executed in the range of 815/- to 820/- and you are in full control of the maximum loss you could have. And As it’s a freak trade the LTP 2000 won’t last more than a second.

  1. When you take Long Position

If you are long on the market, then you should place your SL-Limit Order with Trigger Price Higher than the Limit Price.

Eg. You have a bullish view of ICICI Bank, so you buy ICICI Bank @ 720/- Rs with a risk appetite of a maximum of Rs.10/- share. So you place an SL-Limit order with a Trigger Price of 715/- and a Limit Price of 710/-.

If the market reverses and ICICIBANK price reaches 715/- Rs., your Stop Loss Sell order of 710/- gets activated in the exchange. Since the LTP of ICICI BANK is higher than your Sell Price of 710/- the order gets executed in the market at the Market Price, Let’s say 714/- and booking your loss of Rs. 6/- share. The order can be executed at any price within the range of 715/- to 720/- depending on the market price when your order goes live in the Exchange. 

In Both cases, we have seen that choosing a good Trigger and Limit Price based on your risk management is important, and also a fair breathing space should be given between the Trigger and Limit Price to ensure it gets executed. If you place the Limit and Trigger prices too close like with a 0.5/- or 1/- Rs gap, then chances are there that the LTP has already crossed the Limit price when the order gets activated in the Exchange and your Stop loss order remains open in the exchange.

Selection of the Trigger Price and Limit price is important, and it depends on the Stock or Derivative instrument you trade. It is advised to choose trigger and Limit prices as whole numbers which are multiples of 5 (Subjective to Stock Market Instrument price), as liquidity is often there at those points.

Trade smart and Enjoy your Trading and Investing journey, with discipline, patience, and proper risk management.

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