Financial markets are notoriously volatile, and unforeseen occurrences occasionally have the power to completely alter the trading environment. A recent instance of this kind involved a fat-finger error in a Sensex call option on the expiry day, which led to a dramatic fluctuation in the premium before it returned to normal. This instance highlights the difficulties in trading, the limitations of computational systems, and the potential repercussions of such mistakes.
Credits: Money Control
The Fat-Finger Error: A Market Order Gone Awry
On that fateful day, a trader by the name of SOAMJENA put in a market order to purchase the 67000 call option for just Rs 4-5. However, a “fat-finger” or typing error caused the order to send the premium skyrocketing to an astounding Rs 209 in a matter of minutes. The market order took up all of the sell orders that had been submitted into the system up to a price of Rs 209, which caused the price to spike.
In contrast to a limit price order, a market order does not specify a specific price. Instead, it carries out the order at the best price at the time, until it is fully filled or all pending orders in the system have been matched.
The Unraveling Chaos: A Stop Loss Complication
A stop loss mechanism that was integrated into SOAMJENA’s transaction added another level of complexity to it. The stop loss automatically activated when the premium exceeded a predetermined level, causing the trader’s software to begin selling the options at the best price that was available. Due to the quick sell-off, the premium fell back to about Rs 4.
The nature of the stop loss order, however, caused a disagreement between the trader and the broker. The trader asserted that they had placed a stop loss limit (SL-L) order, which limits the execution of opposing trades to a specific price. The broker countered that the trader had issued a stop loss market order (SL-M), which would have allowed transactions to be executed at any price until the order was cancelled.
The NSE’s Role: Discontinuation of SL-M Orders
It’s important to note that the National Stock Exchange (NSE) stopped offering the stop loss market (SL-M) order option in 2021. This discontinuance was made in an effort to lower the risk involved with such orders and lessen the likelihood of abrupt price changes brought on by automated trading algorithms.
Algorithmic Trading’s Potency on Display
The incident’s abrupt and severe price swings serve as yet another reminder of the importance of algorithmic trading in today’s financial markets. Algorithms are made to operate quickly in response to market developments and carry out trades with the least amount of human involvement.
In this instance, it is hypothesized that competitor algorithms flooded the system with sell orders at higher prices as soon as they noticed the large purchase order for the 67000 call options, effectively compelling the trader to buy all the way up to Rs 209. Other algorithms may have front-ran the order by selling at cheaper prices when the trader tried to close the position, increasing the price volatility.
Mixed Reactions from Traders
Traders’ reactions to the incident’s aftermath were conflicted. Some people—including Kapilan Thirumavalavan (@kapil_thiru)—said they had benefited financially from the mayhem. Kapilan posted about his experience on social media, indicating that the unexpected price increase and subsequent decrease had allowed him to quickly transform a significant loss into a profit.
It’s crucial to note, though, that not all dealers profited from this peculiar turn of events. The quick price changes may have resulted in huge losses for many market participants, particularly for those who took the wrong side of the trades.
Another Recent Incident: Nifty Bank Put Options
It’s interesting to note that this incidence wasn’t unique. Similar anomalies involving Nifty Bank put options with a 45,700 strike price occurred in the futures market on August 11 less than a month earlier. Before the trades were settled, these anomalies briefly caused premiums to decrease by nearly 90%.
The noteworthy part of this episode was the involvement of numerous clients selling put options at a large discount to the going market cost by employing the same algorithmic method. Although the brokers’ and clients’ identities are still unknown, it raises concerns about the risk control procedures in place as well as how algorithmic trading tactics affect market dynamics.
Possible Impact and Lessons Learned:
The fat-finger error in the Sensex call option and the earlier occurrence involving the Nifty Bank put option underscore the constant hazards in the financial markets, particularly given the growing use of algorithmic trading. While algorithmic trading can boost market efficiency and liquidity, it can also increase volatility and present difficulties when mistakes are made.
Such instances can have an influence on investor trust and market integrity in addition to having an effect on certain traders and brokers. To prevent and mitigate such disasters, regulators and market participants must regularly analyze and update their risk management methods.
The fat-finger error in the Sensex call option serves as a harsh reminder of the complex network of variables at play in contemporary financial markets. It’s a complicated ecology that necessitates ongoing attention to detail and adaptation, from order types to market dynamics to algorithmic trading methods. Incidents like this highlight the value of being ahead of the curve in a financial environment that is continually shifting as traders and regulators work to strike a balance between innovation and risk management.