Home / Markets / Stock Markets /  Zerodha founder on how traders can protect against freak trades in options

The founder of Zerodha took to Twitter to say that India's biggest brokerage has been been getting a lot of questions about freak trades in options with huge slippages recently. Nithin Kamath also wrote a blog on how retail investors can steer clear of such freak trades impacting their positions. 

“Over the last couple of weeks, many traders have been sharing screenshots of trades being executed far away from the current market price in F&O contracts on social media, referred to by many as “freak" trades. These incidents are especially around index F&O contracts," he writes. 

Always place limit orders

At times, due to the shallow market depth, you might get unlucky when you place a market order. "Your trade could get executed at a price far away from the current market price in a fraction of a second, causing a significant loss, especially if your order coincides with another large market order on the exchange," he writes. 

One of the ways to cover yourself from a large loss due to a freak trade while also entering/exiting immediately is to use limit orders with a price higher than the current market price for buy orders and lower for sell orders, he said. This will ensure that you are still placing market orders but also are protected against freak trades.

He cites an example to highlight how limit order works. “Assume that an Index call option contract is trading at 100, and you decide to buy five lots at market price. Instead of placing a market order, you can place a limit buy order at 102. This will ensure that your order is treated as a market order and that the impact cost does not exceed 2 points, if at all. Similarly, if you want to sell at the market price of 100, place a limit selling order at say 98 to ensure impact cost is not more than 2 points on the trade," Nithin Kamath writes. 

Zerodha has blocked market orders on stock options for many years now, says Nithin Kamath, adding that due to the extremely shallow market depth, "we have had many incidents in the past with our customers losing money trading market orders on stock options. For customers who want to trade market orders, “we suggest placing limit orders with a price higher than LTP for buying and lower than LTP for selling."

In the Indian market, index F&O contributes more than 90% of all F&O trading volumes. “Most intraday traders looking to enter or exit quickly also mostly trade index F&O. So blocking market orders on Index F&O isn’t the optimal way to ensure customers don’t lose money on freak trades," he said. 

However, “we have come up with a solution where market orders for index F&O with an impact cost of more than a certain percentage of the last traded price will be disallowed."

Use stoploss limit orders

Nithin Kamath also suggests the use of stoploss limit orders over over stoploss market orders, especially when trading contracts with a shallow market depth.

"If you have placed stoploss orders, freak trades on the exchange can trigger your pending stoploss orders. So if you had bought an Index call option at 80 and stoploss at 70, a freak trade at 50 would trigger your stoploss order; there is no way to avoid triggering a stoploss order due to a freak trade. But to ensure your stoploss order triggered doesn’t have a high impact cost due to freak trades make sure to use stoploss limit orders, he says. 

“When trading the markets, there are certain things in your control and many that aren’t. A good trader always does whatever to reduce risk on things that can be controlled, like using limit orders instead of market orders and using SL over SL-M, especially when trading contracts with a shallow market depth," he writes. 

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