In a significant move aimed at bolstering risk management in Equity Derivatives trading, the Bombay Stock Exchange (BSE) is set to introduce the Limit Price Protection (LPP) Mechanism from April 16, 2024. This new mechanism will replace the existing Price Reasonability Check (PRC), marking a pivotal shift in pre-trade risk control measures.
According to the circular released on April 5, the BSE emphasized the need to strengthen pre-trade risk control measures in the equity derivatives segment by implementing the LPP Mechanism starting April 16, 2024.
Simplifying the LPP Mechanism
The Limit Price Protection (LPP) mechanism is designed to prevent orders from being executed at prices significantly deviating from the prevailing market price. It aims to safeguard investors from high volatility and potential order entry issues.
This initiative by BSE mirrors a similar step taken by the National Stock Exchange (NSE) in October 2022, which introduced an LPP mechanism in its futures and options segment to enhance pre-trade risk controls and ensure orderly trading.
Explained with an Example How LPP Works
Consider a stock option with a reference price of Rs. 200. The LPP range for options is set at 60% above and below this price. For instance, buy orders can’t exceed Rs. 320, and sell orders can’t go below Rs. 80. If a trader attempts to place orders outside this range, the system will reject them, ensuring trades occur within a fair price range.
Calculation of Reference Price
The reference price, crucial to the LPP Mechanism, is determined using the Black Scholes model at market open, based on the opening price of the underlying asset. It’s updated every 30 seconds during trading hours to reflect the average trade prices of the last half-minute.
Additional Features and Considerations
- The LPP range is subject to prevailing price bands at the time of order placement.
- Modifications to orders and stop-loss limit orders must adhere to the LPP range to be accepted.
- The LPP mechanism excludes limit price orders in calendar spread futures and option strategy contracts.
- Adjustments to the LPP range may be made based on feedback and the need for recalibration.
Mock Trading for Technical Preparations and Testing
To ensure a seamless transition, trading members and third-party trading application vendors must note changes in the ETI API. Contract-wise LPP ranges will be disseminated through market data broadcast channels. A mock trading session is scheduled for April 13, 2024, to allow participants to test the new system.
BSE highlighted its commitment to regularly review the utilization of these enhancements and make further adjustments based on feedback from market participants and as deemed necessary.
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
