There are two conspiracy theories among a section of derivatives traders. One is that HFTs--also known as quant firms—through their powerful algorithms sniff out stop losses of other traders, and then trigger those with huge buy or sell orders.
Two abrupt intra-day trend reversals in the Nifty 50 index within a month, has sparked chatter that a group of high frequency trading firms using sophisticated technology are colluding to influence the indices. They are allegedly doing so to reap huge profits from their positions in options contracts, which are tied to the movements in the Nifty index, according to some derivatives traders Moneycontrol spoke to.
Coincidentally, the sharp swings on both occasions happened to be on a Thursday, which is the expiry day for weekly Nifty options.
The first was on April 18. The Nifty was stable around 22,300 with two hours left in the session, when it suddenly nosedived 200 points in 30 seconds.
In the second instance on May 16, the Nifty was trading flat to lower over the previous close for much of the session. But in the last 45 minutes, the index rallied over 200 points.
In the first event, buyers of Nifty 22300 put options made a killing and in the second, buyers of Nifty 22300 call raked in the moolah.
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Conspiracy theories
There are two conspiracy theories among a section of derivatives traders. One is that HFTs--also known as quant firms—through their powerful algorithms sniff out stop losses of other traders, and then trigger those with huge buy or sell orders. This sets off a self-reinforcing loop of short covering, which causes options prices to spike briefly.
Such spikes are jokingly referred to as ‘injections’ by F&O traders as the brief spikes form a syringe-like shape on the price charts.
The other conspiracy theory now gaining currency is that some HFTs have formed a cartel and are fiddling with key index components to move benchmark indices even if for a brief while.
Smoking gun
Santosh Pasi, founder of Pasi Technologies, belongs to the camp which strongly feels there is an HFT cartel at work.
He points to the sudden surge in the volumes in 22300 put option on April 8 in just three seconds, which saw the price rocketing from Rs 45 to 392 in under two minutes.
“When the price of the option jumped from Rs 46.30 to Rs 68.90 and then to Rs 117.80, all the bids came in at the same price, which is a bit suspicious, considering that the surge in volumes was massive” Pasi told Moneycontrol. “Hard to believe that all the buyers decided to bid at exactly the same price,” he said.
The other suspicious thing Pasi says he noted is that the prices of the 22300 put options, in the hours before the surge.
“They were not decaying (losing value) at the rate it should have, considering there were just a few hours to expiry. It indicated there was demand for the option even when the market was sideways,” he said.
Circuit Filter
Pasi feels some big algo traders, mostly likely HFTs have found a workaround to the NSE’s Limit Price Protection mechanism, which acts as an intra-day circuit filter for option prices.
The circuit filter for options is different from that for stocks because options pricing swings according to the change in the underlying index or stock and the co-relation between the two is not linear.
Under the LPP rules, options priced at Rs 50 or less can move Rs 20 on either side. The reference point is the simple average of trade prices of that contract in the last 30 seconds and keeps getting revised every 30 seconds.
Options priced above Rs 50 can move 40 percent on either side. But the LPP can be relaxed under certain conditions. One of them is that if there are 10 orders beyond the LPP between two LPP revisions and when such orders involve a minimum of 5 unique client codes and a minimum of 3 unique trading members.
“Technically, if three trading firms have five client accounts it is not hard to push the prices in one direction if they come together,” Pasi says.
The second leg
Options prices cannot be rigged in isolation, they merely react to the change in prices of the underlying. Some derivatives traders say it is relatively easy to influence the price of illiquid indexes, but not as easy to move the price of a highly liquid index like Nifty. Proponents of the conspiracy theory say it is possible to swing the price of even a liquid index like Nifty.
“If you have the resources to move the price of a few index heavyweights by a percent or so even briefly, the resulting swing in the options prices can be much more profitable… even if you were to lose some money while trying to move the underlying,” said a F&O trader who did not want to be quoted.
Also, because the F&O market is dominated by traders using algorithms, a sharp move on one side can be amplified by other algos programmed to move in the direction of the market trend.
Expiry injections
Spikes in options prices of certain strikes on expiry day have become quite common. In some cases, there is reason to believe that the underlying may have been tampered with, traders say.
For instance, on April 8, the day of expiry of Nifty Midcap Select Index, there was a brief plunge in the share price of Indian Hotels. The stock tumbled from a high of around Rs 616 to Rs 566 around 1:30 pm, but rebounded within minutes. Since Indian Hotels has the largest weightage in the Nifty Midcap Select, it briefly sent the index hurtling to the day’s low of 10695. That day, put options on 10,800 strike climbed to high of Rs 134, after starting the day at Rs 12, and was among the most actively traded options contract.
Change in strategy
Previously, expiry day spikes in the prices of certain options would take place without any movement in the underlying. The algos that trigger such stop losses are known as hunter algos in market parlance, as they sus out the stop loss levels of rival traders and then fire the orders.
“Hunter algos were triggering stop losses with freak moves (injections) in options, without any significant move in the underlying index,” derivatives trader Sarang Sood posted on X after the April 18 swing in the Nifty.
“To counter that, smart traders adjusted their systems by placing stop losses based on index moves rather than option prices in their systems. So, what did the hunter do? It gave freak move in the index itself, creating panic in the option chain,” Sood posted.
On balance
Options trader Shreyas Bandi feels that while it is technically possible to swing the prices of even index heavyweight stocks, much of the recent volatility is because of excess positions in the market.
“We have an election result which is two weeks away, and the fact is that relative to previous Lok Sabha elections, the current IVs (implied volatility), are priced lower than what they were in the past, be it in index options or be it in stock options,” Shreyas told Moneycontrol.
“One of the reasons for the low IVs could also be a newfound enthusiasm of people wanting to sell options, even when they are priced lower.
That doesn't change the fact that the market is jittery over the results. So, if any move happens, it immediately creates a cascading effect,” he said.
Shreyas said many professional traders have reduced their positions significantly, but there are enough people who continue to trade heavily unmindful of the risks involved.
He agrees with the view that even index heavyweight stocks can be moved with a few hundred crores of margin money.
“You'd be surprised how little money you actually need to do it,” said Shreyas. “With Rs 300-500 crore of margin money, you can move even the heaviest index stocks between 0.5-1.0 percent,” he said.
In other words, if some players want to move a certain stock or set of stocks, they can do that through sizeable bets on the stock’s futures.
“But the market will try to correct such abrupt moves. So, it's not that easy to swing prices. But at the same time, is it, is it done? Hundred percent. For weekly expiries, you just need to move it for a short time” he said.
The bigger issue according to Shreyas is the nervousness in the market over the election results.
“The entire market is on the edge right now and at the same time, risk is underpriced. If you are a seller of options, you will be more scared and looking to jump out at the first sign of trouble. So, you could see more of such sharp swings in the day ahead,” he said.
Global phenomenon
Allegations of big traders manipulating spot prices to profit on their derivatives positions are voiced globally too.
A report by website risk.net cites a study by researchers from Robeco, the Chinese University of Hong Kong and Copenhagen Business School analysed derivatives data from February 2003 to December 2021. They identified a price spike in equity index futures in the hours before market open on the third Friday of the month – the day when many options expire, also nicknamed ‘witching day’.
The researchers tested different theories for why the spike should appear and concluded that only market manipulation seems able to explain its existence, the report said.
The difference points to a wealth transfer of about $3.8 billion a year, most likely from market participants that are long puts and short calls to those who are short puts and long calls.
