Mastering Derivatives: Understanding market wide position limit

Venkatesh Bangaruswamy | Updated on: Mar 12, 2022

This is important given the impact on derivatives trading

There may have been occasions when you were unable to take fresh positions in futures or options on the NSE. This is because of a rule called Market Wide Position Limit (MWPL) that NSE applies based on SEBI guidelines. This week, we discuss MWPL and its impact on derivatives trading.

Open position

MWPL refers to the maximum open position in futures and options on an underlying across exchanges. For instance, MWPL for Reliance was set at 64.84 crore for March 2022. This means open positions (in equivalent contracts) in futures and all option strikes across all months on Reliance Industries is capped at that level. Note that NSE halts trading in futures and options on an underlying when open interest touches 95 per cent of MWPL.

You can find the list of securities on ban period on the NSE website. Following a ban after open interest hits 95 per cent of MWPL, traders are allowed to only close their existing position. So, traders with long position can sell and those with short position can buy. The objective is to reduce the open interest position. NSE resumes trading on all futures and options contracts on that underlying when open interest falls to 80 per cent of MWPL.

MWPL is set at the lower of 30 times the average shares traded in the previous calendar month or 20 per cent of the non-promoter holdings (free float). You can find daily updated information relating to MWPL on each underlying on the NSE website. MWPL rule helps in moderating short squeeze. This refers to sharp increase in prices because of excess demand for shares (compared to supply) from traders who want to cover short positions. In the absence of MWPL, suppose the number of near-month contracts exceed free float shares (shares available for trading) of the company. Traders with short call or short futures position may find it difficult to buy shares at reasonable prices to fulfill their delivery obligations at contract expiry.

As an individual trader, you do not have to be overly concerned about the MWPL if your objective is to take profits before the expiry of the near-month contract. Why? You can initiate long or short positions in options or futures if the open interest is below 95 per cent of MWPL. What if the security subsequently hits a ban period? You can still close your position and take profits. But to recover losses, you cannot repair your existing strategy if it requires adding new position. For instance, you cannot convert an open (loss-making) bull call spread into a ratio spread as that would amount to adding a short position on a higher strike call.

Optional reading

You would find several suggestions on the Internet about how a trader can use MWPL. For instance, it is argued that if MWPL is greater than 80 per cent and racing towards 95 per cent and the underlying price is increasing, it is a signal that market participants have a positive outlook on the underlying. Another argument is that an increase in average MWPL (say two per cent) that is greater than the increase in the Nifty 50 Index (say 1.5 per cent) is taken as a positive signal. Before you draw such conclusions, remember that MWPL increases only when fresh long and short positions are added to the existing open interest. How can you determine who is likely to be right: long or short trader?

MWPL is a risk management tool implemented by exchanges to moderate excessive build-up in derivatives position on an underlying. You should be cautious about using this information as a signal for setting up trading strategy. Note that you cannot roll over your existing positions in the event the security is in a ban period. This is because MWPL applies to all expiry contracts on the underlying.

The author offers training programmes for individuals for managing their personal investments

Published on March 12, 2022
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