Chapter1

AlgorithmTrading

Definitionandtypeofalgorithmtrading
Algorithmtradingreferstoautomatedtradingbasedonalgorithm.Thepurposeof usingautomatictradingistoanalyzepriceandmarketconditionsinordertotradeatthe minimumcostbasedontherelevantalgorithmmethod. Algorithmic Trading can be defined as the use of computer programs for entering trading orders where the computer algorithm decides on aspects of the trade execution such as the timing, price, or quantity of the order. Algorithm Trading is also known as automatedtrading,algotrading,blackboxtradingorrobotrading.Algorithmsdynamically monitormarketconditionsacrossdifferentsecuritiesandtradingvenuestomakethetrade executiondecision.Algorithmictrading(AT)ismorecomplexthanelectronictradingandit encompassesmanyformofcomputeraidedtradingincludingHighFrequencyTrading. Algorithmic Trading is widely used by pension funds, mutual funds, and other buy side(investordriven)institutionaltraders,todividelargetradesintoseveralsmallertrades inordertomanagemarketimpact,andrisk.Infact,algorithmswereoriginallydevelopedfor use by the buyside to manage orders and to reduce market impact by optimising trade executiononcethebuyandselldecisionshadbeenmadeelsewhere.Sellsidetraders,such asmarketmakersandsomehedgefunds,provideliquiditytothemarketbygeneratingand executingordersautomaticallywiththehelpofalgorithms. AlgorithmTradingisbroadlycategorisedintoHighfrequencytrading,BasketTrading, MultiExchangetradingandothercategory.BasketTrading(Programtrading)isgenerally usedforstockbaskettrading.Multiexchangetradingistradingaproductacrossdifferent exchangesusingcomputeralgorithm.MultiexchangetradingisfacilitatedbySmartOrder Routingalgorithms.Smartorderroutingisatechniqueofusingtheclosecorrelationof majorexchangesandcrosslistingofacompanyi.e.,placingordersonanexchangewhere themostfavourableconditionsareseen.InIndia,SEBIalloweduseofSmartOrderrouting inAugust2010andcurrentlyitisoperationalinbothCapitalMarketaswellasCurrency DerivativeSegmentOthercategoryheretoreferredasAlgorithmTrading/Algorithmic Trading/ATinterchangeably,referstoanyandallkindofcomputeraidedtradingwhichdoes notfallunderfirstthreecategories.Algorithmtradingfocusesonminimizingthemarket impactbysplittingtrades.Algorithmtradingwasoriginallydevelopedasanorderplacement systemforthepurposeofminimizingtradingcost,butitisnowbeingusedasanoverall termtodescribeitsstrategyandprocess.

Algorithm Trading BasketTrading (Programm Trading) MultiExchange Trading(Trading usingSOR) Other Algorithmic Trading

HighFrequency Trading

Strategiesoralgorithmsusedbythecomputertoautomate(enter,modifyorcancel)trade ordersarecalledalgorithmictradingstrategiesandtheyarebroadlyclassifiedasexecution strategies,profitseekingstrategies(Alphastrategies)andarbitragestrategies. Arbitragestrategies AlphaSeekingstrategies Executionstrategies Algorithmtradingiswidelyusedamonginstitutionalinvestorslikepensionfundsand investmentcompaniesbecausecostcanbesavedthroughbulkorders,reducingtheimpact onthemarketandpreventingtheexposureoftradinginformation.Algorithmtradingalso helpsreducetradingcost. ThemostcommontypesofexecutionalgorithmareVWAPandTWAP.VWAPsplitsorder volumebasedonhistoricaldata.TWAPsplitsorderovertime.Themarketparticipation strategyismanipulatingtradingvolumesothatspecificordersdonotaccountfora significantpartoftotaltradingvolumeonthemarket.Ontheotherhand,theinlinestrategy ismanipulatingordersorpricessothattheydonotsurpassalimitprice.

Arbitr ragestrat tegies

AlphaSeeking Strat tegies

Directional Trading Strategies Mean Revesion es Strategie

CostRedu C uction/ Exe ecutionS Strategies

Benc chmark algo orithms (V VWAP, Imple ementati onSh hortfall, Partic cipation (%Vo olume), Targe etClose, TWAP P,InLine, etc) e Liquidity seeking algorithms s (CrossFire, , Hunt,Iceber rg, etc)

Delta a Nuetr ral

Sta atistical Arb bitrage

EventBa ased Arbitra age

Scalping Strategies

Dark Liquidity g Seeking Strategie es

eBuysidefi irmsandSellsidefirms? Whatare Buysidefirmsrefertoinstitutionsconcerne edwithbuyin ng,ratherth hanselling,a assetsor securities s.Privateeq quityfunds,m mutualfund ds,unittrusts,hedgefun nds,pension nfunds,and proprieta arytradingd desksarethe emostcomm montypeso ofbuysideentities. Buysidefirmsusuallytakespecu ulativepositionsormake erelativeva aluetrades.B Buyside rticipateina asmallernum mberofoveralltransact tions,andaim mtoprofitf frommarket t firmspar movements. Sellsidefirmsrefers stoinstitutio onsthattake eordersfrom mbuysidef firmsandthe en"work" theordersbyslicingthenintosm mallorders.Brokeragefi irmsandMa arketmaking gfirmsare mmonexamplesofsells sidefirms. mostcom Sellsidebrokeragesareregistere edmembers sofastocke exchange,an ndsometime estheyare etmakersin nagivensecurity. requiredtobemarke mission(brok kerage),advisoryfeecha argedtobuy ysidefirm SellsidefirmsprofitfromComm bidofferspr read. andtheb

Algorithmtradingsystem

Source:Exchangehandbook

Chapter2 ATWherewestandgloballyandinAsia? OnMarketEnvironmentFront Singapore&HongKongScoreTopinchart India Japan Australia Taiwan China OnRegulatoryForcesFront HongKong Australia Singapore Japan Taiwan India China(MostRestrictedmarketinworldfortrading) OnTechnologyEnablersFront Singapore(HighestinvestmentontechnologyfrontinAsia) Australia Japan HongKong India Taiwan China OnAlgorithmicTradingFront HongKong(48%ofvolumetradedalgorithmically) Singapore Australia India&Japan China

AlgorithmicTradinginAsiaPacific Amongasiapacificcountries,algorithmicactivityishighestinHongKong(39%)followedby Singapore(31%),Japan(26%),Australia(20%)andIndia(15%).Algorithmictradingin HongKongisslatedtoreach61%in2012fromcurrent39%.Indiawascautiousinitsuseof AlgoTrading,buthaslotofpotentialtogrow.Bytheendof2012,ATactivityinIndiais expectedat30%fromcurrent12%.

Source:CelenetResearch Asiaisaveryexcitingmarketforelectronictradingofcashequityandderivatives.Whilethe levelofdevelopmentofeachmarketdiffers,theleadingexchangesinJapan,Australia, Singapore,HongKong,andIndiashouldsetthetone,withfastermatchingengines, enhancedmarketdata,andcolocationservices.Withahighproportionofitsdomesticbuy sidebeginningtousealgorithmictrading,HongKongisbestpoisedtogrowintheregion.It isfollowedbySingapore,wheretheregulatoryenvironmentisveryconducivetoalgo trading.Similarly,Japan,andAustraliaareexpectedtohavehigheralgotradingincoming years.Finally,Indiahasbeenaslowstarterbutisrapidlycatchingupwithsomeofits counterpartsandisexpectedtohavealgotradinglevelsofaround30%by2012 AnshumanJaswal,CelentSeniorAnalyst

EvolutionofElectronicTradinginIndia HFTisnotyetintroducedinIndia.

MilestonesinIndianEquityMarkets

DomesticBuySide startedAlgoTradingoperations SmartOrderRoutingIntroduced (DomesticSellSide startedAlgoTradingoperations) DMAIntroduced AlgorithmicTradingBegins IntroductionofDerivativesinIndia InceptionofNSEandStartofelectronicTrading

1994'

200001

200304

2008'

2010'

201011

2011'

ThefollowingisthesolutionpresentedbytheSingaporeStockExchangetoreduceorder fulfillmenttime:1)improvingdataqualitybyusingColocationandexpandingnetwork bandwidth;and2)reducingorderfulfillmenttimebycombiningdifferenttechnologiesvia efficientapplicationsolutionsandlayerednetworks.Inaddition,theexchangeisusing advancedsoftware,whiledevelopingappliancebasedchiptechnology.

 SmartOrderRouting SEBIalloweduseofSORinIndia,BSEintroducedSORfacilityfortradingmembersonSept 29,2010andNSElauncheditonOctober13,2010.SORfacilityisallowedtobeofferedtoall classofinvestorsasdirectedbySEBI.MembersdesirousofprovidingSORfacilityshallmake anapplicationtotheExchangeinspecifiedformat. Membersarerequiredtotestthesoftwareonassociatedexchangestradingtest environmentduringaprespecifiedtime.Onsatisfactorycompletionoftestingonthe Exchangetestenvironment,thememberisrequiredtogivecomprehensivedemonstration oftheirSORfacilitytotheExchange.Onfulfilmentoftheconditionsassatisfactoryand meetingSEBI/Exchangeminimumrequirements,theExchangewouldgrantpermissionto themembertocommenceSORfacility. Requirements: a. SORcanbeusedonlytorouteorderstorecognisedstockexchanges b. ThebrokerserverroutingordersplacedthroughSmartOrderRoutingsystemofthe ExchangeshallbelocatedinIndia. c. Thetradingmembershalldeterminetherecognisedstockexchangewheretoroute theorderorpartoftheorderbasedonfactorslikeprice,costs,speed,likelihoodof executionandsettlementsizeandnaturerelevanttotheexecutionoftheorder. d. IdentificationofordersroutedthroughSmartOrderRouting:13thdigitof15digit ordercodeisusedtoidentifySORorderatNSE.

AtBSE14thDigitof15digitorderisusedtoidentifySORorder 14thdigit 4or6 "4" OnlySOR "6"SORthroughDMA e. ThesoftwareandsystemsproposedforSORisrequiredtobedulycertifiedby SystemAuditorbeforegrantofpermission. SmartOrderRoutingisoneoftheuniqeorderprocessingsystemofferedbystock exchangesinIndia.Thisservicewouldhelpinvestorstoexecutetradeatbest availablepriceatthatpointintime.SORhelpspricediscoveryprocessandensures thateveryassettradedatdifferentvenueswillhavesimilarprice.

DirectMarketAccessFacility DirectMarketAccess(DMA)isafacilitywhichallowsbrokerstoofferclientsdirectaccessto theexchangetradingsystemthroughthebrokersinfrastructurewithoutmanual interventionbythebroker. SomeoftheadvantagesofferedbyDMAaredirectcontrolofclientsoverorders,faster executionofclientorders,reducedriskoferrorsassociatedwithmanualorderentry, greatertransparency,increasedliquidity,lowerimpactcostsforlargeorders,betteraudit trailsandbetteruseofhedgingandarbitrageopportunitiesthroughtheuseofdecision supporttools/algorithmsfortrading. DMAtrafficaccountsfor1518percentoftotaltradingvolumesintheUSand8percentin Europe.DirectMarketAccesstradersinhighfrequencyprogramshavethegreatest demand. SEBIallowedTradingMemberstoprovideDMAfacilityinApril2008fortradinginequities, futuresandoptionssegment. Connectivity IndianbrokersneedFIXconnectivitytoattractinternationalorderflowandmanyhave madesignificantinvestmentsinFIXnetworksandordermanagementsystems(OMSes).The widespreadadoptionoftheFIXprotocoloverthelasttwoyears,allowedmanycountriesto allowDMAfacility. InIndiabothNSEandBSEhaveFIXconnectivity. Colocation IndianExchangeshavestartedprovidingcolocationfacilitytotheirmemberbrokers, wherebytheycanplacetheirtradingserversclosetotheexchangesengineonafirstcome firstservedbasis.Colocationsavescrucialmillisecondsfromthetimeittakestoplacean orderanditsreceiptattheotherend.Thebrokerwithhisservernexttotheexchange enginegetsapricefeedthatisupdatedeverythreefourmilliseconds,whileabrokerata remoteplacewillgetthisfeedupdatedevery3040milliseconds. NSEstartedcolocationfacilitiesforitsmembersinJanuary2010andthepaceofadoption isfascinating.Withcolocationfacilities,memberscansetupautomatedtradingsystemsin thesamebuildingastheexchange.Withthis,thetimetakenformarketdatagoingoutfrom theexchangeandforordermessagestocomeinfrommembers(alsoknownaslatency) reducesconsiderably

InarecentFuturesIn ndustryAsso ociation(FIA A)conference einMumbai,anofficialfromthe ange(NSE)sa aid60%oftheordersco omingintotheexchange ewerefrom NationalStockExcha edservers. colocate Latency referstoamountoftime etakentoel lectronically ysendorrec ceiveinforma ation.HFTs Latencyr relyonverylowlatency(i.every yquickdatat transmission n)fortradingstrategies. .Worldwide e esareinvest tinginnewt technologyt toreducelat tency. exchange chnologiesU UniversalTra adingPlatfo orm NYSETec 3milliseconds TimeLag gfordatafee ed TimeLag gfororder& &cancel Acknowle edgment TimeLag gforRoundT TripExecutio on at(timefromorderconfirmationtotrade executiontotradeco onfirmation) ) 2milliseconds

Nasdaqlistedissue 650micros seconds NYSElist tedissue9 950microsec conds BATS:40 00microseco onds DirectEd dge:300500 0microsecon nds Recently,NYS SElaunchedEthernetba asedmarket tdatadelive erysolutionthathas25 condslatencyatratesof f1million20 00bytemessagesperse econdperco ore. microsec peed(Round dTripExecut tionTime)atmajorexch hanges Ordersp

KRX K 80, ,000 S

HK KE 10,0 000 S

SGX 000 10,0 S S

BSE E 10,00 00 S

LSE 0 6,000 S

TSE 5,000 S

NSE 5,000 S

ASX 250 S

NDAQ 143 S

NYSE 25 S

Capacity Capacityreferstoab bilityofanex xchangetoh handleorder rflowatany ygivenpoint tintime. Withintr roductionof fAlgorithmT Tradingnow wmanystock kexchangesarestrugglin ngtokeep pacewith heverincrea asingcapacitydemands.Theyarein nvestinginn newtechnolo ogiesto increasecapacityino ordertofaci ilitateMultil lateralTradingFacility. nsetochang gingenvironment,BSEin ncreasedcap pacityfrom1 1000orders spersecond Inrespon to20,000 0ordersper rsecond.NSEalsoiswor rkingtoward dsincreasing gcapacity.

AverageTradesizeandNumberoftrades Averagesharespertrade(AverageTradesize)decreasedby83%from1,477sharesin1997 to244sharesin2009,whileAveragetradesperDay(NumberofTrades)increasedby26 timesfrom743tradesin1997to19,943tradesin2009.AveragesharesPerDayincreased from1.09mn(1477*743)in1997to4.86mn(19943*244)in2009.Thefiguresshowthat thereisbeenincreaseinnumberoftradesexecutedanddecreaseinordersize.Thiscanbe attributedtointroductionofalgotradingwhichslicelargeorderintomanysmallorders.The negativeimpactofthisisthatitmayfloodthesystemwithlargenumberoforders increasingtheloadonexchangestradingsystem.Alsoitincreasesclearingandsettlement costsfortraders. US Equity Share volume and trades 40,000 1,600 35,000 1,400 30,000 1,200 25,000 1,000 20,000 800 15,000 600 10,000 400 5,000 200 0 0 Avg Shares Per Day (mm) Avg Trades Per Day Shares / Trade AverageOrderCancellationRate
SinceintroductionofAT,OrdertoTraderatiohassignificantlygoneupinmanycountriesincluding India.AtNYSEordertotraderatiois30:1,whichmeansonlyoneorder,outof30ordersentered, getsexecutedand29othersareeithermodifiedorcancelled.ATBSEordertotraderatiois19:1.

Theincreaseintheaverageordertotraderatioandaverageordercancellationratemaynobethe concernaslongasexchangeshavebuiltsufficientlylargecapacityandhavelimitedorderentryrate throughalgorithms.

Avg. Shares / Trade

Chapter2 RegulatoryActionsWorldwide

Chapter3 Reasonsforusingalgorithmsintrading

TypesofAlgorithmsUsedbythebuysidefirms

 Source:AlgorithmTradingSurvey2010conductedbyTradingscreen Overtheyears,algousagehasevolvedfromlesssophisticatedparticipation strategiessuchasVWAPandTWAPtomorecomplexpriceimprovementapproachesthat seektominimiseslippagefromatargetprice.Asaresultin2010,Implementationshortfall (IS)forsinglestockshasriseninpopularity,upfrom39%in2008to68%.VWAPsawthefirst notabledeclinesince2008initsuseamongbuysiderespondentsdownfrom64%to58%. UseofTWAPalsodeclinedmarginallyfrom23%in2010to20%in2009. Darkliquidityseekingalgorithmssearchesallthedarkpoolseliminatingtheneedto splitanorderinsearchofliquidity.Darkliquidityseekingalgorithmsaremostwidelyused algorithmsbybuysidefirmsin2010,constituting81%ofrespondentsuse,upfrom51%a yearago.Similarly,albeitfromalowbase,therehasbeenafivefoldincreaseintheuseof algorithmstotakeadvantageofinternalcrossingopportunities,upfrom5%in2009to25% in2010.Percentageofrespondentsusingvolumeparticipationstrategyandbasket implementationshortfallstandat62%and20%respectively.

US Equity Share Volume by Market Participant2009

28% 29%

16% 13% 7% 4% 3%

Retail

HFT Broker/ Market Makers

Independent HFT

HFT Hedge Funds

Hedge Funds

Long Only

Investment Bank Prop

61%volumeinUS 39%volumeinUS

HFTs(MarketMakers/LiquidityProviders/SellSidefirms) NonHFTs(Investors/BuySidefirms) SourceTABBGroup

AlgorithmicTrading ATistheuseofcomputerprogramsforentering trading orders with the computer algorithm deciding on aspects of the order such as the timing,price,orquantityoftheorder Algorithmic Trading is computer aided but not necessarilyHighfrequencyorlowlatencytrading Accounts for 70% volume traded in US equity in 2010.NonHighfrequencyAlgorithmicTradingis only14%inUS. ATfirmsholdingperioddependsonstrategythey employ.Theymayholdpositionsforfewminutes or for few years or they might never sell it. Typicallyaverageholdingperiodislong.

HighFrequencyTrading HFT is highly quantitative, employing computerized algorithms to analyze incoming market data and implement proprietary trading strategies HFTispartofAlgorithmicTrading Accounts for 56% volume traded in US Equity in 2010. HFT usually implies a firm holds an investment positiononlyforverybriefperiodsoftimeeven justsecondsandrapidlytradesintoandoutof thosepositions

AT firms include both DayTraders and Position HFT firms are typically DayTraders and end a Traders and may carry overnight position trading day with no net investment position in dependingonstrategytheyuse thesecuritiestheytrade. AToperationsareusuallyfoundinBuySidefirms (such as Mutual funds, Insurance companies, Pension funds, FII, Investment Banks, some HedgefundsandsomeProprietarytradingfirms) Selecting High Profit Making and properly backtested algorithms is more important than speed.SpeeddoesmatterinATtoo,butneedfor speedisnotanutmostpriority. ApplicationofAlgoTrading Directional Trading : Trend Following, Pair Trading,MeanReversion,Scalping Arbitrage : Delta Neutral Strategies, Statistical Arbitrage Transaction cost reduction(Trade Execution) : VWAP, TWAP, Liquidity seeking, Implementation shortfall HFT operations are usually found in proprietary firms or on proprietary trading desks in larger, diversifiedfirms HFT strategies are usually very sensitive to the processingspeedofmarkets(alsocalledLatency) andoftheirownaccesstothemarket. ApplicationofHFT RebateTrading,MarketMaking, FilterTrading,MomentumTrading, StatisticalArbitrageandTechnicalTrading

Chapter4

HFTanditsimpac ctonMarketQuality
4.1Data aSample
Datasam mplechosenforstudying gimpactofH HFTinstocks slistedoneitherNASDA AQorNYSE areasfollows Sam mple:Listo of120stocks slistedoneitherNASDA AQorNYSE AA ARCC B BZ CNQR CTS C SH FFIC GPS KTII MOD PNY P AAPL AXP CB C COO C DCO OM FL HON LANC MOS PPD P ABD AYI CBEY C COST DEL C LL FMER R HPQ LECO MRTN P PTP ADBE AZZ CBT C CPSI C DIS FPO IMGN LPNT MXWL R RIGL AGN BARE C CBZ CPWR DK C FRED INTC LSTR NC ROC R AINV BAS CCO C CR C DOW W FULT IPAR MAKO NSR ROCK R AMAT BHI CDR C CRI C EBA AY GAS ISIL MANT NUS ROG R AMED BIIB CELG C CRVL C EBF F GE ISRG MDCO NXTM R RVI AMGN BRCM C CETV CSCO ERIE C E GENZ Z JKHY MELI PBH SF S AMZN BRE CHTT C CSE C ESR RX GILD KMB MFB PFE SFG S ANGO BW CKH C CSL C EWBC GLW KNOL MIG PG SJW S APOG BXS CMCSA C C CTRN FCN N GOOG KR G MMM PNC SWN S

Source:HighFrequencyTradingandItsImpactonMarketQualitybyJonathanBrogaard, Sept2010 Note:Thesestatisticsareanaggregatefor26HFTfirmstradingactivityin120stocksfor fiscalyearendingonDecember31,2009.

4.2HFTactivityinUS
HFTsareinvolvedin68.5%ofalldollarvolumetradedinthesample.Theirlevelofdaily involvementvariesfrom60.4%to75.9%.Theydemandliquidityin42.7%ofalldollar volumetradedandsupplyitin41.1%. HFTsparticipatein73.8%ofalltradesandparticipationvariesatthedaylevelfrom65.1%to 81.9%.Theydemandliquidityin43.6%ofalltradesandsupplyitin48.7%. PanelA>DollarVolumetradedbyHFTsaspercentageofTotalDollarVolumetradedinthe sampleof120stocks PanelB>QuantitytradedbyHFTsaspercentageofTotalQuantitytradedinthesampleof 120stocks

Source:HighFrequencyTradingandItsImpactonMarketQualitybyJonathanBrogaard, Sept2010 Note:Thesestatisticsareanaggregatefor26HFTfirmstradingactivityin120stocksfor fiscalyearendingonDecember31,2009.

4.3DoHFTsfleeinvolatilemarkets?
WhileHFTmaybeincreasinglyprovidingliquiditytothemarketintheplaceofmore traditionalmarketmakingactivities,someinvestorssuggestedthatunlikeregisteredmarket makersontradingvenuesthereisnoobligationorincentiveforhighfrequencytradersto

continuetoprovideliquiditytothemarketintheeventofadversemarketconditions(high volatility). ResearchshowsasindicatedinGraph1,HFTsactivityappearstobealmostflat acrossvolatilitylevels.EvenonthemostvolatiledaysHFToverallactivitydoesnotseemto increaseordecreasesubstantially.However,whenvolatilityislowHFTsactivityislessthan average. HFTactivitymorethanaverage

HFTactivityLessthanaverage

Where, HFT%ChangePercentchangeinHFTactivity HFT%MA(9)9DaymovingaverageofpercentchangeinHFTactivity 95%confMA(9)UpperandLowerpricebandofHFT%MA(9) Source: HFTprovideabout10%moreliquiditythanusualonverylowvolatilitydays.ThelevelofHFT liquidityslowlydeclinesasvolatilitypicksup,atthehighestvolatilitytheHFTliquidityis about10%lessthanonanaverageday.

HFTactivitymorethanaverage

HFTactivityLessthanaverage

OntheleastvolatiledaysHFTtakeabout7%lessliquiditythannormal,andonthemost volatiledaystheytakearound5%moreliquiditythannormal.

HFTactivitymorethanaverage

HFTactivityLessthanaverage

TheseresultsshowthatHFTactivitydoeschangewithvolatility,butnotprecipitously.In particularonthemostvolatiledays,HFTdonotpulloutofthemarket.Onthesedays,there doesseemtobea510%transferofHFTactivityfromsupplyingliquiditytodemanding liquidity.

4.4DoHFTscontributetoPriceDiscoveryProcess?
Ofthe118stocks,68stocksshowashavinggreatercontributiontopricediscoveryprocess and28ofthosestocksHFTNonHFTcontributionisstatisticallysignificant.Inthe50stocks, wherenonHFTcontributionisgreaterthanthatofHFT,thedifferenceisstatistically significantfor7firms. OnaverageHFTcontribute86%,[(0.1950.105)/0.105*100],moretopricediscoverythando nonHFT.BasedontheseresultswecansafelysaythatHFTcontributetopricediscovery process. Table14:HFTnonHFTVarianceDecomposition

 WhereHFT%shows Variance(EfficientPrice,HFTtradeprice) NonHFT%shows Variance(EfficientPrice,NonHFTtradeprice) TStat tstatisticsfordifferencebetweenHFTandNonHFTcontributiontopricediscovery Source:

4.5WhatroleHFTplaysinprovidingmarketliquidity?
ThissectionanalyzesHFTandthesupplyofliquidity. a) DoHFTordersprovideinsidequotesmoreoftenthanNonHFTorders? Insidequoteiseitherbestbuyquoteorbestsellquote Table16:TablereportsnumberofminutesduringwhichHFTsareatthebestbidoroffer.

(ThetimeduringwhichbothHFTsandnonHFTsarebothatthebestquotesisalsoincluded inthevalue.)

PanelA allstocksatalltimes, PanelB thestocksthatareofferinglowerspreadsthanaveragealltime PanelC thestocksthatareofferinglowerspreadsthanaveragealltime IneachPanelthedataaredividedintothreegroups,with40firmseach,basedonfirmsize Viz.Small,MediumandLarge Sample=780=2(Providingeitherinsidebid/offerevery minute)*60(minutes/hour)*6.5(tradinghours)=NumberofminutesthataHFTcould potentiallybeprovidingatleastoneinsidequote PanelAshowsthatHFTfirmsfrequently(ataround65.3%(=509.3/780*100)ofthetimeof theday)providethebestbidorofferquotes.AsthefirmsizeincreasesHFTsaremore competitiveintheirquotes,matchingorbeatingnonHFTsquotesforasignificantportionof theday. AlsothereisnosignificantdifferencebetweenliquidityprovidedbyHFTfirmsinHighspread &Lowspreadstocks

b) DoesHFTprovidedepthtotheorderbook? Inprevioussection,theanalysisonliquidityhasbeenbylookingatthebestinsidebidand asks.AnotherwayoflookingatHFTimpactonliquidityisbylookingatthedepthofthe booksuppliedbyHFT.PanelAandBshowsincreaseinimpactcostduetowithdrawalof eitherHFTordersorNonHFTorders. Firmsaredividedbasedontheirmarketcapitalizations.VerySmallincludesfirmsunder$ 400million,Smallarethosebetween$400millionand$1.5billion,Mediumarethose between$1.5billionand$3billion,andlargeareforfirmsvaluedatmorethan$3billion. Dollar Dollarincreaseinimpactcost Basis Percentincreaseinimpactcost PanelAshowstheresultsofremovingHFTfromthebook.Asthetradesizeincreases,the priceimpactincreasesacrossfirmsofallsizesandforalltentradesizeincreases.TheSmall categorytendstobemoreimpactedbythewithdrawalofHFTliquiditythanistheVery Smallcategory.

PanelBshowstheresultsofremovingnonHFTsfromthebook. AcrossallcategoriestheremovingofnonHFTshasamuchlargerimpactthandoesthe removalofHFTs.ThismeansthatalthoughHFTssupplyliquidityin41%ofalldollarstraded, theyprovideonlyafractionofthedepthcomparedtononHFTs.

Conclusion:Beyondsupplyingliquidityin51.4%ofalltrades,HFTsfrequentlysupplythe insidequotesthroughouttheday.Whileremovingeithertypeoftraderwouldresultina priceimpactsoftrades,removingnonHFTshasalargerimpact

4.6DoHFTgenerateordampenvolatility?
Assumption:Priceswouldhaveachievedtheiractuallevelsevenintheabsenceofhigh frequencytradesbutwouldjumparoundmore. Ofthe120firms,72ofthemhaveahighervolatilitywhenHFTrinitiatedtradesare removed.Further,AsmallmajorityoffirmsexperienceslightlyhighervolatilitywithoutHFTr initiatedtrades.Howeverofthese72stocks,onlyoneisstatisticallysignificant.This indicatesvolatilitywouldhaveincreasedintheabsenceofHFT. Ofthe48stockswheretheremovalofHFTrinitiatedtradesreducesvolatility,suggestiveof HFTscausingvolatility,noneshowastatisticallysignificantdifferenceinvolatility.

Conclusion:TheoverallresultsshowthatwhenHFTrinitiatedtradesareremoved,volatility increasesandthisdifferenceisstatisticallysignificant.Admittedlytheresultsarenotstrong inonedirectionoranother;theyleaninfavourofHFTreducingvolatility.

Chapter5

PossibleManipulationsUsingHFT/AlgorithmicTrading
1) FrontRunning Frontrunningisanillegalactivityinwhichatradertakesapositioninanequityin advanceofanactionwhichhe/sheknowshis/herbrokeragewilltakethatwillmove theequity'spriceinapredictablefashion. ApartfromFlashTrades(discussedbelow),whichsomebelieveispartofFront Running,thereisnooccurrenceoffrontrunningusingAlgorithmicTrading. FlashTradingServicesshowstockpricinginformationtosomeselectmember around500millisecondsbeforeroutingittopublicmarket.Ifsuchordersareoflarge quantity,fewmemberscantakeadvantageofitbyfrontrunning. In2008,SEBIallowedstockexchangestoofferDMAfacility,whichmanybelieve helpsInstitutionswithlargeorderstoexecutethetradesdirectlyonstockexchange withoutmanualinterventionofTradingMember. ThereisnoconclusiveevidencethatwoulddefinerelationshipbetweenFront runninganduseofAlgotrading.Andhence,useofAlgorithmicTrading(without usingDMA)willnothaveanysignificantimpactonIncreaseordecreaseofnumber ofinstancesoffrontrunning. 2) Orderstuffing/Quotestuffing Quotestuffingisessentiallyadenialofserviceattack,aimedattryingtoslowdown amarketinanenvironmentwheremillisecondsmatter. Withquotestuffing,highfrequencytradersenteranenormousnumberofbidsand offers,significantlyoutsidethecurrentbidofferspread,justtointroduceavast amountofnoiseintothequotefeed.Allthatnoisetakestime(maybejustafew extrananoseconds)forrivalHFTshopsandExchangesTradingSystemstoprocess, givingthequotestufferacrucialtimeadvantage. TheSECislookingintowhetherquotestuffingexists,andwhetheritsastrategythat anybodyhasactuallyusedtomakemoney.Theyarealsoinvestigatingwhether Quote stuffinghasanyinvolvementinFlashCrashthathappenedonMay6,2010. InIndia,myguessisquotestuffingmaynotexistsatthispointintime,givenvery lowparticipationbyHFTsbutagainwecannotruleoutchanceofhappeninginthe futurewithmoreandmorepenetrationbyHFTs.Quotestuffingisworldwide regardedasveryseriousactandshouldbepunishedseriouslyifattemptedbyany marketparticipants. 3) FlashTrades

Flashordersshowsstockpricinginformationforabriefperiodtoalimitedgroupof membertraderswhocanthendecidewhethertofillanorderbeforeitisroutedout tothepublicmarket. DirectEdge,anelectroniccommunicationsnetworkbackedbyGoldmanSachs, CitadelandKnightTrading,wasthefirsttooffersuchanordertypetoitsmembers in2006.NASDAQandBats(U.S.exchanges)createdtheirownflashmarketinearly 2009inresponsetotheDirectEdgemarket.Bothvoluntarilydiscontinuedthe practiceinAugust2009. DirectEdgebecameaU.S.exchangeinJuly2010andusedflashtradingtogreat successinsiphoningmarketvolumeawayfromNYSE,BatsandNasdaqandnowit claimsthirdlargestexchangeinUS.CurrentlySECisconsideringbanningFlash TradinginUSfollowingcomplaintbyEuronextoperatorofNYSEandGletcoOneof thetopmarketmakersinUS. Officially,sofar,nostockexchangeinIndiaisofferingthisservicebutintroductionof SORmayopenthegatesofopportunitiesforstockexchangestoattractinstitutional tradersbyprovidingflashtradingfacility.Flashtradingservicegivesunfairadvantage toselectgroupofpeople/institutionsattheexpenseretailinvestors.Thisserviceis detrimentaltothedevelopmentofsecuritiesmarketandSEBIshouldenact regulationstobanitsoperationinIndia. 4) Internalisation Internalisationreferstoabilityofbrokerstomatchcustomersawayfrompublic markets. InIndia,SEBIhasbannedinternalcrossingofordersandmandatedthatall ordersenteredbyclientsmustbesubmittedtocentralordermatchingsystemofthe exchanges.Thispreventssettingupofstealthstockexchanges,darkpoolsorprivate tradingvenues,stealingliquidityawayfromthemarket. Inspiteofhavingsuchstrongregulations,Icannotruleoutthepossibilityof useofalgorithmstodevelopInternalCrossingsystems,whichIamsuremany brokeragefirmswouldbeetchingtostartinordertoreducetransactioncostfor theirproprietarytrades.HighcostoftransactioninIndiacouldactuallyworkasan impetusforuseofsuchsystems. 5) Layering LayeringisatechniqueofenteringLimitOrderswithlargequantityatdifferentprice levelonanysideoforderbookinordertocreateafalseappearanceofbuyorsell sidepressure.

Person,whowantstobuyastock,entershiddenbuyorderatbestbidandenters numerousselllimitorderwithlargequantityatsuchapricelevelsthathavelow probabilityofgettingexecuted.Thiscreatesanimpressionthattherearemany sellersinthescriptandhenceitmaygodowninducingotherpeopletoselltheir stockstobuyer(manipulator) InIndia,Layeringmaynotbeusedthatextensivelymainlybecauseabsenceof DeepOrderBook.Only5bestbidsand5bestoffersareprovidedinIndiafora particularscriptasagainstallpossibleordersprovidedinUS.Thislimitstheabilityof DayTraderstotakeacallbasedondemandandsupplyofthestock.Layering requiresasmanylimitorderstobevisibletoeffectivelyimplementit. Havingsaidthis,IstillsuspectmanycasesofmanipulationusinglayeringinIndiain LowVolumeorilliquidscriptswithoutthehelpofHFT.Permittinguseofalgorithmic tradinginLowVolumestocks,mayaggravatethisproblem.Soifpermitted,itshould beverifiedthatLayeringalgosarenotpermittedtouse. FINRAimposed$1millionpenaltyonTrilliumBrokerageServices,LLCforusingan illicithighfrequencytradingstrategy Trillium,throughnineproprietarytraders,enterednumerouslayered,nonbonafide marketmovingorderstogeneratesellingorbuyinginterestinspecificstocks.By enteringthenonbonafideorders,ofteninsubstantialsizerelativetoastock's overalllegitimatependingordervolume,Trilliumtraderscreatedafalseappearance ofbuyorsellsidepressure. Thistradingstrategyinducedothermarketparticipantstoenterorderstoexecute againstlimitorderspreviouslyenteredbytheTrilliumtraders.Oncetheirorders werefilled,theTrilliumtraderswouldthenimmediatelycancelordersthathadonly beendesignedtocreatethefalseappearanceofmarketactivity.Asaresultofthis improperhighfrequencytradingstrategy,Trillium'stradersobtainedadvantageous pricesthatotherwisewouldnothavebeenavailabletothemon46,000occasions. Othermarketparticipantswereunawarethattheywereactingonthelayered, illegitimateordersenteredbyTrilliumtraders.

6) Darkpools 7) WashTrades Anillegalstocktradingpracticewhereaninvestorsimultaneouslybuysandsells sharesinacompanythroughtwodifferentbrokersinordertoincreaseturnoverand inturncapturetheattentionofgeneralpublicenticingthemtotradethestock. TheresearchconductedbyASXsuggeststhatthereisbeenanincreaseinthe numberoftradesbeingcancelled,majorityofwhichwereWashTrades,from0.16% inJan2009to0.39%inAug2009.ThereasonbehindthisismanyAlgoTradingfirms employdifferenttradingStrategiesvizarbitragestrategies,marketmaking strategies,directionalstrategiessimultaneously.Thisincreaselikelihoodthatbids andoffersenteredfromthosealgoswillinadvertentlyexecuteagainsteachother. 8) Liquidity Detection
Liquiditydetectionisanumbrellatermfortradingstrategiesthatinvolvesendingsmall orderstolookforwherelargeundisclosedordersmightberesting,ontheassumptionthat Whenasmallorderisfilledquicklythereislikelytobealargeorderbehindit.Someofthe commonliquiditydetectionstrategiesare: Pinging:sendingoutlargenumbersofsmallorderswiththeintentionofgettingafillorto gaininformationaboutelectroniclimitorderbooks; Sniper:anAlgorithmthattriestodetecthiddenliquiditybytradinginroundoroddlots untilitcompletesorreachesaninvestorslimitprice; Sniffing:Usedtosniffoutalgorithmictradingandthealgorithmsbeingusedbysendinga smallportionofanorderwaitingtoseeifsomeonecomesandgetsit.Sniffersattemptto outsmartmanybuysidealgorithmictechniqueslikeiceberging. AsurveywasconductedbyTABBgrouptofindwhetherliquiditydetectionisaformof manipulation.74%ofmarketparticipantssaidthattheydidnotregardliquiditydetectionas aformofmanipulation,becausethetraderdoesnothavedirectknowledgeofanorder.

Concerns:
a) AreNSEandBSEequippedforpotentialattackontheirservers/Ordermatching systemsbyQuoteStuffers?Ifyes,havetheydonestresstesting? b) Havetheybuiltsufficientlystrongordermatchingsystemwithlargecapacity, Highthroughout&LowLatency(TurnaroundTime)tohandleLargeOrderFlow attremendousspeed? c) Arestockexchangescapabletodetectandstopalloftheabovemanipulations onrealtimebasis?AndIfyes,How? d) HowstockexchangeswillensuresApprovedLimitsarenotviolatedbytrading membersandtheirclientsonrealtimebasis? e) Whatpunitiveactionswillbetakenifexchangesfoundanyofthe abovementionedmalpracticesusedbyTMortheirclients?Orwilltheyoncase tocasebasis?

Recommendations:
Iseenorealdangerinallowinginternalisationofproprietarytradingasit avoidsextracostssuchasSTTonintradaytransactionsforTM.However,internal matchingofclientsorderinternallyoracrossdifferentTradingMembershouldnever beallowedasitraisesseveralClearingandSettlementissuesandalsothereisreal riskofnewunregulatedtradingvenuessuchasdarkpoolbeingsetup. SEBIneedstobeproactiveindefiningalloftheaboveoperationsas fraudulentpracticesandhencebanningitsoperationinIndia.

Chapter6

HighFrequencyTrading
Highfrequencytrading(HFT)isasubsetofalgorithmictradingwherealargenumber oforders(whichareusuallyfairlysmallinsize)aresentintothemarketathighspeed,with roundtripexecutiontimesmeasuredinmicroseconds.Programsrunningonhighspeed computersanalysemassiveamountsofmarketdata,usingsophisticatedalgorithmsto exploittradingopportunitiesthatmayopenupformillisecondsorseconds.Participantsare constantlytakingadvantageofverysmallpriceimbalances;bydoingthatatahighrateof recurrence,theyareabletogeneratesizeableprofits. Typically,ahighfrequencytraderwouldnotholdapositionopenformorethanafew seconds.EmpiricalevidencerevealsthattheaverageU.S.stockisheldfor22seconds. TABBgroup,afinancialservicesindustryresearchfirm,estimatesthatHFTnow accountsfor56%ofturnoverinUSAand38%turnoverinEuropeintheequity segment.

AsperLondonstockExchangesresponsetoCESRquestionnaire,inthefirstquarter of2010,numberofordersexecutedthroughHighFrequencyTradingaccountedfor 33%oftotalturnoverintheEuropeanmarket.

Chapter6 AlgorithmicT A Tradingstrat tegies

Arbit tragestrategies

Alph haSeeking g Str rategies

Directional Trading s Strategies Me ean Revesion egies Strate

CostRe eduction/ ExecutionStrateg gies

B Benchmark a algorithms ( VW WAP,Implem m entation Sh hortfall,Parti i cipation(% c Volume),Targe e t Clo ose,TWAP,I I n nLine,etc) Liquidity seek king algorit thms (CrossFi ire,Hu nt,Icebe erg,etc )

DeltaNu uetral

St tatistical Arbitrage

EventBased age Arbitra

Scalping s Strategies

DarkLiq quidity Seek king Strate egies

(Detailsa aboutTradin ngstrategies sareoutlinedinAnnexure3&DetailsaboutBenchMark algorithm msandLiquidityseekingalgorithmsareprovided dinannexur re2)

HighFrequencytradingstrategies

Chapter7

CurrentRiskManagementframeworkinIndia
PriceBandsinEquityandF&OSegment InIndia,therearepricebandsof2%,5%,10%and20%onindividualsecurity. Nopricebandisapplicableonscripsonwhichderivativeproductsareavailable.Restall securitiesarecategorisedindifferentcategoriesbasedontheirdailyvolumeandimpact cost.2%,5%,10%and20%bandsareapplicableonthosecategories. Oncescriphitapricebandoneitherside,tradingishaltedforremainingday. InF&O,therearenopricebandsbuttopreventerroneoustradeentry.Operationalprice bandsaredefinedas10%forIndexfutures,20%forstockfuturesandDeltabasedvaluefor Stock&indexoptions. IndexwiseCircuitFilter/CircuitBreakers IndexwiseCircuitFilterisanautomatedtradinghaltmechanism,whichstopstradingonthe exchangeforspecifiedperiodoftime. Thereare10%,15%and20%circuitbreakersontwomainindicesNifty&Sensex. 10%movement 15%movement 20%movement 9:15am 1.00pm 1.00pm 2.30pm 1HrmarketHalt 1/2HrmarketHalt 9:15am1.00pm 1.00pm2.00pm 2HrmarketHalt 1HrmarketHalt TradingHaltedforrestoftheday 2.30pm3.30pm NoTradingHalt 2.00pm3.30pm TradingHalted

MarginingSysteminEquityandF&O IndianmarketsaremuchbetterplacedvisvistheUSmarkets,thankstothepracticeof collectingmarginsonarealtimebasis.Ifamemberfirmexhaustsitsmarginwithan exchange,itisbarredfromtakingfreshpositions.IfclientortradingmemberorClearing membercrossesspecifiedlimits,tradingfacilityissuspendedforallclientstradingthrough TM(incaseTMviolateslimit)andalltradingmemberclearingthroughCM(incaseCM violateslimit). StocksarecategorizedinGroupI,II&IIIonthebasisofimpactcostandstockstradedinlast 6monthsforthepurposeofassigningdifferentmarginsondifferentcategorieshaving differentrisk. InEquity,InitialMargin=VaRmargin+Exposuremarginiscollectedonupfrontbasis, TypicallyVaRMarginisintherangeof7.515%andExposuremarginrangesbetween5 10%.Sotypically,totalinitialMarginVariesfrom12.525%.MTMmarginiscalculatedby

markingeachtransactioninsecuritytotheclosingpriceofthesecurityattheendoftrading. Andcollectedbeforestartofnexttradingday InF&O,InitialMarginandExposuremarginarecollectedupfront.InitialMargin=Total SPANMargin(VaRmargin)+BuyPremium+AssignmentMargin.AndExposureMargin3% ofthenotionalvalueofafuturescontract(forfutures)&Thehigherof5%or1.5standard deviationofthenotionalvalueofgrossopenposition(foroptions).TotalInitialMarginis typically1520%ofTransactionValue.MTMmarginsarecollectedbeforestartofnext tradingday. PositionLimits AttheendofeachdaytheExchangedisseminatestheaggregateopeninterestacrossall Exchangesinthefuturesandoptionsonindividualscripsalongwiththemarketwide positionlimitforthatscripandtestswhethertheaggregateopeninterestforanyscrip exceeds95%ofthemarketwidepositionlimitforthatscrip.Ifyes,theExchangetakesnote ofopenpositionsofallclient/TMsasattheendofthatdayinthatscrip,andfromnextday onwardstheclient/TMsshouldtradeonlytodecreasetheirpositionsthroughoffsetting positionstillthenormaltradinginthescripisresumed. InIndia,wehaveTMwise&clientwisepositionlimits,whichpreventasingleTMora singleInvestorfromtakinghugepositioninasinglestock.Forclientsitis1%ofTotalFree floatcapitalisation(forcash)and5%ofMWPL(forF&O) NSEAlsomonitorFIIandMFpositionsforsectoralandcompanyspecificlimitssetbyRBI& SEBI. Therearestiffpenaltiesforviolationofanyoftheabovementionedlimitsandmargining requirements. PretradeControlinF&Osegment QuantityFreeze:AnyordercomingtotheexchangefortradeinNIFTY,S&P500, BANKNIFTY,CNXITorMINIFTYfuture/optionwithquantitymorethan15,000willbeFreezed untilbrokerconfirmitasagenuineorder.Fortradeinfuture/optiononindividualstocks, freezequantityisasdecidedbyexchangefromtimetotime. PriceFreeze:PricefreezeisoperationalonlyintheF&Osegment.Operationalpricebands aredefinedas10%forIndexfutures,20%forstockfuturesandDeltabasedvalueforStock &indexoptions. PretradeControlinEquitysegment Apartfrompricebandstherearenopretradecontrolsinequitysegmenttocheck erroneoustrades.InUSerroneoustradesthatareexecutedwayoutsidelasttradedprice

maybecontestedandcancelledaftercomplainingtotherespectivestockexchange.Ihave giventwocaseswheretradeswerecancelled. PersonallyIdontthinkanytradeshouldbecancelledevenifitisthepunchingerror. Recommenduseof5%DynamicPriceBand Whyisitimportanttoimplementsuchstringentoperationaldynamicpricebands? ThereweretwocasesinthehistoryofIndianSecuritiesMarketthatcausedtremendousloss tothebrokingfirmsandtheirclientsduetopunchingerrorsbyoperators. Bothofthesecasescouldhavebeenavoided,hadtherebeen5%pricebandoperational. Havingnarrowpricebandof5%ensuresthatasingletradecantmakeanystockfallbymore than5%.
Case1:NYSEEuronextcancelledalltradesinthe$74.8billionSPDRS&P500ETFTrustthat occurredatalmost10percentbelowthesecuritysopeningprice,accordingtoanemailsentby theexchange. ThetradesoccurredontheNYSEsArcaplatformat4:15p.m.NewYorktimeon18/10/2010and pricedtheexchangetradedfundthattrackstheStandard&Poors500Indexat$106.46 comparedwithitsopeningpriceof$117.74.TheETFplunged9.6percentovereightsecondsas 7.2millionsharestradedonNYSEArca,accordingtodatacompiledbyBloomberg.TheS&P500 rose0.7percenttocloseat1,184.71today.Theglitchoccurredaftertheclosingauctionwas delayedduetoasoftwareupgradeattheexchange.Officialclosingpriceineachsecurityis decidedinanauctionprocessconductedaftercloseofthemarket. Case2:Nasdaq&NYSEcancelledalltradesin296securitiesthatwereexecutedatgreateror lessthan60%oftheirpricesat2:40p.m.ETonMay6,2010 FirstcasewasofpunchingerrorinTulipITservicesonJan5,2006.TulipITServicessawtwo unusualtradeshappeningonitslistingday.Onedealsaw4,04,800sharessoldat25paiseeach againsttheaveragepriceofRs185attheBombayStockExchange,whiletheothersaw5,95,575 sharessoldatRs100each. ThosedealscausedtheselleralossofRs12.69croreinjust38 seconds.ThefirsttransactionledtoanetlossofRs7.40crorewhilethesecondtransactioncost Rs5.06crore. ThesecondcaseisfreaktradeinRelianceonJune1,2010.Amarketordertosell1.6lakhshares wasenteredinReliancebyadealeratabrokermemberfirmwhichgotmatchedwithlimit purchaseordersinthetradingsystem.Withinfewsecondsofenteringorder,Reliancestock plungedtoRs840.55frompretradepriceofRs1,010causingscripttofallby19.56%.Many analystsbelievethistrademighthavecostbrokingfirmamorethanRs1crore.

ProcedureforgrantingpermissiontoTradingMemberforAlgorithmTrading a) NSE,onMay17,2011,issuedacirculartosmoothentheprocessandfacilitateearly approvalofdecisionsupporttools/algorithmsfortradingthroughnonneatfront end.Itcategorisedapplicationforseekingapprovalinalgotradinginthreemain categoriesviz.ApprovedAlgorithmsthroughCTCL,NonApprovedAlgorithms throughCTCLandDMAAlgorithms.ThiscategorisationgivesNSEoptiontoscrutinize newalgosmorefortheirpretradeandposttraderiskcontrolsthanalready approvedalgos. b) OnfulfilmentofconditionsassatisfactoryandmeetingSEBIandExchangesminimum requirements,theexchangewillidentifythevendors/membersalgorithmas Approvedalgorithm. c) Totalproceduretakesaround30daystogetalgoapprovedfromdayofapplication. (Fordetailsrefertoannexure4. Concerns 1) NSEisnotdisclosingriskcontrollimitstopublic.Soitraisesconcernsthatprocess maynotbetransparentandtheremayexistdifferentlimitsfordifferentclients. Recommendations 1) NSEshoulddiscloseriskcontrollimitsontheirwebsiteasspecifiedintheformat below. AlgorithmWise FirmWise MaxNumberofAlgosallowedto operatesimultaneously MaxNumberofOrderspersecond NA

2) NSEtoprepareMonthlyReportonAlgoTradinginformatsspecifiedinTable1and shouldprovidetoSEBIasandwhenneeded.Sinceturnoverbeingcompanyspecific datawecannotpublishitinourMonthlyBulletinandannualReports. 3) ButfortheinformationofInvestors,exchangesneedtopublishtotalturnover throughalgotradingeverydayonitswebsite.TheyshouldalsoprovidedatatoSEBI informatspecifiedinTable2.ThishelpsSEBIensurethattherequiredinfrastructure forAlgoTradingisinplaceandalsoitprovidesInvestorsanoptiontoexitthe market,iftheyfeelthereishighamountofAlgoTradingActivity,whichisnot suitabletotheirriskprofile.

Table1

Nameof theFirm 1

Typeoffirm Dateof Numberof (BuySide/ approving algos Sellside) 1stalgo approved 2 3 4

Orders entered 5

Orders Cancelled 6

Orders Traded 7

Average Size(Qty) ofthe order

TotalTurnover (Monthly) Average Optedfor OptedForCo Valueofthe DMA Location? Through Through Order facility? Active Passive Orders Orders 8 9 10 11 12 13

Table2 Capacity(Orderspersecond) Latency(RoundtripExecution time) Latency(Datafeeds/Info disseminationtime) AverageDailyOrders OrderFlow(throughDMA facility) Orderflow(throughAlgo Trading) AlgoTradingvolumeas PercentageofTotalVolume OrderFlow(throughCoLocation facility Numberofordersdivertedto otherStockExchangesthrough SOR NumberofAlgosregistered NumberofBuysideFirms registeredforAT NumberofSellsideFirms registeredforAT BSE NSE

RiskManagementFrameworkatthetimeofalgorithmapproval CurrentlyNSEhasfairlystrongcheckstoapprovealgorithms/decisionsupporttools;the onlythingweshouldbeconcernedaboutisitsimplementation,fairnessinimplementation andtransparency. Thealgoapprovalprocessincludesfollowingchecksatindividualandclientlevel: Table2 S No. Requirement Whether complied (Yes/No) YES/NO YES/NO YES/NO YES/NO YES/NO

1 Doessoftwareperformfollowingchecksbeforeroutingorderstothe exchangeforexecution? 2 3 4 5 IndividualOrderLevel: QuantityLimitscheck PriceRangechecks Tradepriceprotectionchecks Ordervaluechecks ClientLevel: Netpositionv/savailablemargins RBIviolationchecksforFIIrestrictedstocks MWPLviolationchecks Positionlimitchecks Tradinglimitchecks Exposurelimitchecksatindividualclientlevelandatoveralllevelforall clients DoesthesystemhaveProvisionforgeneratingandmaintainingcomplete AuditTrail. CantheordersgeneratedbyAlgorithmictradingproductsbeidentifiedas AlgorithmorderswhilereleasingtotheExchange AllordersgeneratedbyAlgorithmictradingproductsareofferedtothe marketformatchingdirectlyandnocrosstradesaregenerated? Doesthesystemhavesufficientsecurityfeaturesincludingpassword protectionfortheuserID,automaticexpiryofpasswordsastheendofa reasonabledurationandreinitialisationofaccessonenteringfresh passwords?

Directcontroloffilters:DeterminedbywhethertheParticipanthasexclusiveandcontinualaccess tosetandamendavailableprereleaseorderfilters. Presubmissionorderlevelfilters:Filtersthatassessanorderasadiscreteunitratherthanaspart ofanaccount.Filtersaredesignedtopreventerrorsinprice,valueanddirectcompliancesuchas shortselling. Presubmissionaccountlevelfilters:Filtersthatassessanorderinthecontextofaccountlevel exposure.Suchfiltersdependonaconsolidateaccountpositionirrespectiveorexecutionvenue. Exchange Filtered

1. Introductionof5%dynamicpricebandsonallsecurities OperationalPriceBandrequirementshouldbemadestringentforalgorithmtrading topreventsystemsfromenteringerroneoustrades. Forstockswithpricelessthanorequalto10,operationalpricebandshouldbe5%of thelasttradedpriceinallscriptslistedatNSE&BSE.Thispricebandwillchange everysecondwitheverynewtradehappening. Justforexample:IfaXYZstockiscurrentlytradingatRs100,Anyalgotrading systemwillnotbeabletoenterbuyorderatmorethanRs105andsellorderatless than95. Placingabuyorderbelowcurrentmarketprice&placingasellorderaboveCMPwill improveliquidityasthiswouldincreasenumberofpassiveorderssittingintheorder book.SoinourexamplebuyerwouldbeabletoenterbuyorderatlessthanRs95 andsellorderatmorethanRs105. However,thisrulewillbeanexceptionforstoplossorder.InstopLossordertrader canplacetriggerpriceandlimitpriceatanypricehedesires. ThisruleshouldalsobeapplicableonthefirsttradingdayoftheIPO. 2. Mechanismtoflushoutallthependingorders
3. IntroductionofMakerTakerStructure Anexampleofanewtradingstrategythathasemergedoverseasandattractedthelabel predatoryisa FormofarbitragedesignedtoensurethattheHFTreceivesarebateforprovidingliquidityto aretailorinstitutionalinvestor.Thisstrategyistheresultofmarketmicrostructurechanges whichmakecertaintypesoftradingprofitableforhighfrequencytraders,wherepreviously thiswasnotthecase.

Chapter9 Conclusion Highfrequencytraderstendtosticktoliquidstocksandliquidderivativescontracts.Hence, theyhaventyetcontributedmeaningfullyinenhancingliquidityoftheotherstocksand illiquidderivativescontractssuchasstockoptions. Needlesstosay,thelargerconcernabouthighfrequencytrading(HFT)isthatitcould destabilizemarkets,especiallyaftertheflashcrashintheUSon6May2010.Itmustbe notedthatsuchasituationcanariseeveninaworldwithoutHFT.Aflashcrashsituation ariseswhenalargeorderisplacedintoathinorderbookinadvertently. Therearemixedviewsontheimpactsofalgorithmtradingwillbeonthemarket.Positive Impactsmayincludeenhancedliquidityandtransactioncostsavings,whilenegativesmay Includeunderminedmarketstabilityduetofrequenttrading. Ibelievethatactivealgorithmictradingwillservegreatlytomanagethemarketimpact,as wellasreducinganysideeffectscausedbyalgorithmsniffing.Howeveritistruethat algorithmtradingitselfhascreatedsomenegativessuchaslowsettlementratesandsystem overloadissues,whichneedtoberesolved. SGXemphasizeshighspeedmessaging,theshorteningofmarketdatadelays,andresearch onnew products.

 AnnexureIII A) GeneralAlgorithmicStrategies 1) TrendFollowing Trendfollowingisaninvestmentstrategythattriestotakeadvantageoflongterm movesthatseemtoplayoutinvariousmarkets.Thesystemaimstoworkonthemarket trendmechanismandtakebenefitfrombothsidesofthemarketenjoyingtheprofitsfrom theupsanddownsofthestockorfuturesmarkets.Traderswhousethisapproachcanuse currentmarketpricecalculation,movingaveragesandchannelbreakoutstodeterminethe generaldirectionofthemarketandtogeneratetradesignals.Traderswhosubscribetoa trendfollowingstrategydonotaimtoforecastorpredictspecificpricelevels;theysimply jumponthetrendandrideit. 2) PairTrading

Thepairtradingisamarketneutraltradingstrategyenablingtraderstoprofitfrom virtuallyanymarketconditions:uptrend,downtrend,orsidewisemovement.Thistrading strategyiscategorizedasastatisticalarbitrageandconvergencetradingstrategy. 3) DeltaNeutralStrategies

DeltaNeutralstrategyisalsoknownasCashF&Oarbitragestrategy.Deltadenotes changeinoptionpricewithonerupeechangeintheunderlyingassets.Deltaforcalloption isintherangeof0to1,whereasforputoptionitvariesfrom1to0.Deltaforstock/future isalways1.Sobuying/sellinganyofthethreeassetsinspecificquantitycanmakeour portfoliodeltaneutral. Arbitragerbenefitsfromdecayingoptionvalue(theta)ifheisshort.Arbitragercanalso benefitfromincreaseinvolatilityifheislongvolatilityandviceversa. 4) Arbitrage

Basically,arbitrageisexploitingbenefitofmispricedassetstoearnriskfreeprofit.

Therearetwotypesofarbitrage a) Cashcasharbitragewhenaparticularscriptistradingatdifferentpricesattwo differentexchangesortradingvenue,arbitragercanbuythestockwhichischeap andsellthestockwhichisexpensive.Thishelpspricediscoveryprocess.InIndia, smartorderroutingandmultiexchnagetradingwiththehelpofalgorithmsisstill underprocessofclearance b) CashFuturearbitrageWhenthereisdivergencebetweenSpotandfutureprices foraparticularscriptandthereisariskfreeprofitaccordingtocashandcarry model,arbitragermaypurchaseastock/futurewhichischeapandsellfuture/stock whichisexpensive,simultaneously. Arbitrageisnotsimplytheactofbuyingaproductinonemarketandsellingitinanotherfor ahigherpriceatsomelatertime.Thetransactionsmustoccursimultaneouslytoavoid exposuretomarketrisk,ortheriskthatpricesmaychangeononemarketbeforeboth transactionsarecomplete.Inpracticalterms,thisisgenerallyonlypossiblewithsecurities andfinancialproductswhichcanbetradedelectronically,andeventhen,wheneachlegof thetradeisexecutedthepricesinthemarketmayhavemoved.Missingoneofthelegsof thetrade(andsubsequentlyhavingtotradeitsoonafterataworseprice)iscalled 'executionrisk'ormorespecifically'legrisk. 5) MeanReversion

Meanreversionisamathematicalmethodologysometimesusedforstockinvesting,butit canbeappliedtootherprocesses.Ingeneraltermstheideaisthatbothastock'shighand lowpricesaretemporaryandthatastock'spricewilltendtohaveanaveragepriceover time. Meanreversioninvolvesfirstidentifyingthetradingrangeforastock,andthencomputing theaveragepriceusinganalyticaltechniquesasitrelatestoassets,earnings,etc. Whenthecurrentmarketpriceislessthantheaverageprice,thestockisconsidered attractiveforpurchase,withtheexpectationthatthepricewillrise.Whenthecurrent marketpriceisabovetheaverageprice,themarketpriceisexpectedtofall.Inotherwords, deviationsfromtheaveragepriceareexpectedtoreverttotheaverage. 6) Scalping

Scalping(trading)isamethodofarbitrageofsmallpricegapscreatedbythebidaskspread. Scalpersattempttoactliketraditionalmarketmakersorspecialists.Tomakethespread meanstobuyattheBidpriceandsellattheAskprice,togainthebid/askdifference.This procedureallowsforprofitevenwhenthebidandaskdonotmoveatall,aslongasthere aretraderswhoarewillingtotakemarketprices.Itnormallyinvolvesestablishingand liquidatingapositionquickly,usuallywithinminutesorevenseconds. Theroleofascalperisactuallytheroleofmarketmakersorspecialistswhoaretomaintain theliquidityandorderflowofaproductofamarket.Amarketmakerisbasicallya specializedscalper.Thevolumeamarketmakertradesaremanytimesmorethanthe

averageindividualscalpers.Amarketmakerhasasophisticatedtradingsystemtomonitor tradingactivity.However,amarketmakerisboundbystrictexchangeruleswhilethe individualtraderisnot.Forinstance,NASDAQrequireseachmarketmakertopostatleast onebidandoneaskatsomepricelevel,soastomaintainatwosidedmarketforeachstock represented. Transactioncostreduction Transactioncostreductionstrategiesarebasicallyorderexecutionalgorithmsandtheyfall undertwomaincategoriesnamelyBenchmarkalgorithmsandliquidityseekingalgorithms. Largeordersarebrokendownintoseveralsmallerordersandenteredintothemarketover time.Thesuccessofthisstrategymaybemeasuredbytheaveragepurchasepriceagainst theTargetPricesuchasVWAP,TWAPforthemarketoverthattimeperiod. Benchmarkalgorithmsarebettersuitedforlongerdurationorders(from30minutestoone day,dependingontheliquidityofthetradedstock),becausetheycontroltheexecution rate.ExamplesofBenchmarkalgorithmsareVWAP,ImplementationShortfall,%Volume, TargetClose,TWAP,InLine,etc. Conversely,liquidityseekingalgorithmsareshorttermandtheycanexecute100%ofan orderveryrapidlyifmarketconditionsarecompatiblewiththeorderparameters. ExamplesofLiquidityseekingalgorithmsareCrossFire,Hunt,Iceberg,etc. 8) Strategiesthatonlypertaintodarkpools 7)

Recently,HFT,whichcomprisesabroadsetofbuysideaswellasmarketmakingsellside traders,hasbecomemoreprominentandcontroversial.Thesealgorithmsortechniquesare commonlygivennamessuchas"Stealth"(developedbytheDeutscheBank),"Iceberg", "Dagger","Guerrilla","Sniper","BASOR"(developedbyQuodFinancial)and"Sniffer".[26] Yetareattheircorequitesimplemathematicalconstructs.Darkpoolsarealternative electronicstockexchangeswheretradingtakesplaceanonymously,withmostorders hiddenor"iceberged."Gamersor"sharks"sniffoutlargeordersby"pinging"smallmarket orderstobuyandsell.Whenseveralsmallordersarefilledthesharksmayhavediscovered thepresenceofalargeicebergedorder. B) HighFrequencyTradingStrategies 1) Marketmaking MarketmakingisasetofHFTstrategiesthatinvolvescontinuouspostingpassivelimitorder tosell(oroffer)abovethecurrentmarketpriceorabuylimitorder(orbid)belowthe

currentpriceinordertoprovideliquiditytoothermarketplayersand,inthisway,benefit fromthebidaskspread. Profitabilityisenhancedbythefactthatmanytradingcentresapplythemakertakerfee structure.Thisstrategyisoftencalledmarketmakingbuttodosomaybeinappropriate. SomeHFTfirmsregisterwiththetradingvenuesonwhichtheyarememberstomeetthe ongoingobligationsassociatedwithbeinganofficialmarketmaker.However,thisisoften notthecase,asHFTfirmsmayactinsteadasinformalliquidityproviders,avoiding prescribedmarketmakingobligationsandenjoyingbenefitsofthetraditionalmarket makers.Bylookingattradedvolumes,HFTfirmshavebecomesignificantparticipantsinthe liquidityandpriceformationprocessinmanymarketsandinstrumentsand,evenwhen actinginformallyinthisrole,havepartlyreplacedtraditionalmarketmakers.Lowlatencyis oftheutmostimportanceforthisstrategysinceprovidingliquiditymightinvolveholdinga riskyinventorypositiononaninstrumentforsometime.Marketriskisminimizedbyrapidly adjustingpostedquotestoreflectthearrivalofnewinformationortoadjustinventory.Asa consequence,theratiooforderstotradesandthenumberofcancelledordersareveryhigh inthisstrategy. 2) ArbitrageStrategies

Arbitragestrategiestakeadvantageofpricingdiscrepanciesandmayinvolvepurearbitrage betweenthesameinstrumentstradedacrossdifferenttradingvenues(e.g.thesamestock tradedatanexchangeandanATS/MTF),betweenanindexandtheunderlyingbasketof securities,orbetweenrelatedinstruments(e.g.asecurityandanassociatedderivative). Otherformsofarbitragelookatstatisticaldeviationsfromlongterm,historicalstatistical relationships(e.g.correlations)amongsecurities.Assumingreversiontothemean, significantdeviationsfromtheserelationshipsofferprofitabletradingopportunities. Arbitragestrategiestendtoimprovepriceefficiencybyeliminatinginconsistenciesbetween prices.Theyalsotendtoconsumeratherthanprovideliquiditytothemarket,astheshort livednatureofarbitrageopportunitiesmakesrapidexecutionoftradescritical. 3) Directionalstrategies

Directionalstrategies,includingeventstrategies,involveunhedgedpositionsbeingcarried for some (albeit often short) period of time, in anticipation of small but lasting intraday pricechanges.Basedonpastpatterns,HFTfirmsestimateexpectedpricechangestriggered bythereleaseofmacroeconomicnews,corporateannouncementsorindustryreportswith asignificantimpactonmarketprices.Aspasteventsgeneraterecognizableandstatistically robust patterns, HFT firms estimate expected price responses to anticipated events. Anotherdirectionalstrategyisaliquiditydetectionstrategywhichinvolvesafirmsearching for hidden demand for liquidity in the market. Undisclosed demand is liquidity that is not reflectedintheorderbookandinthemarketprice.Thestrategyprofitsbymovingtheprice againstlargehiddenbuyingorsellinginterest. (SourceIOSCOreportonregulatoryissuesraisedbytheimpactoftechnologicalchanges onmarketintegrityandefficiency)

 AnnexureIV ProcedureforgrantingpermissiontoTradingMemberforAlgorithmTrading 1. Procedureformakinganapplication Tradingmemberdesirousofseekingapprovalfortradingusingalgorithmsshouldmake anapplicationinformatasspecifiedinAnnexure1 NSEcategorizedalgorithmapplicationsforapprovalinthreecategories,whichareas follows d) ApprovedAlgorithmsthroughCTCL TradingMember,desirousofusingalgorithmswhicharealreadyapprovedbyNSEto thevendors,canmakeanapplicationinthiscategory.Memberneednotgive

demonstrationoftheAutomatedRiskmanagementfeaturesasthatpartisalready donebytheVendor. e) NonApprovedAlgorithmsthroughCTCL TradingMember,whointendstousealgorithmswhicharenotapprovedbyNSE, mustmakeanapplicationinthiscategory.TradingMembermustgive demonstrationoftheAutomatedRiskmanagementfeatures.Andsubsequently, membershallberequiredtoinformNSEincaseofanychangetoapproved algorithms. f) DMAAlgorithmsTradingMember/InstitutionalClientsAlgorithms Irrespectiveofwhetheralgorithmisapprovedornot,TradingMembersor InstitutionalclientswhointendtousealgorithmthroughDirectMarketAccess facility,mustmakeanapplicationinthiscategory. 2. Procedureforalgorithmapproval OnfulfillmentofconditionsassatisfactoryandmeetingSEBIandExchangesminimum requirements,theexchangemayidentifythevendors/membersalgorithmas Approvedalgorithm. 3. AdditionalCategoryofNonNEATuserswillbeintroduced ExchangeisplanningtoprovideseparateNonNEATuseridstothememberswhoare usingNonNEATfrontendfortrading.Suchmemberswillnotbeallowedtologin/trade throughNEATbutwilluseitonlyforriskcontrolandtradevalidation. ThisisverypositivesteptakenbyexchangetohelpmemberswhoarenotusingNEAT fortradingtomanagerisks. 4. RiskManagersforAlgorithmTerminal Eachriskmanagersshallbeallowedtomanagemultiplealgorithmsundersinglerisk managementsystem.Henceitwouldbeconsideredassingledealerforthecompliance purpose. AnnexureV CurrentRiskManagementframeworkinIndia A) Categorisationofstocksforimpositionofmargins Stockareclassifedintothreecategoriesonthebasisoftheirliquidityandimpactcost.

The Stocks which have traded at least 80% of the days for the previous six months shall constitutetheGroupIandGroupII. Outofthescripsidentifiedabove,thescripshavingmeanimpactcostoflessthanorequal to1%arecategorizedunderGroupIandthescripswheretheimpactcostismorethan1, arecategorizedunderGroupII. TheremainingstocksareclassifiedintoGroupIII. Theimpactcostiscalculatedonthe15thofeachmonthonarollingbasisconsideringthe order book snapshots of the previous six months. On the basis of the impact cost so calculated, the scrips move from one group to another group from the 1st of the next month. B) MarginsintheEquitysegments

Dailymarginspayablebymembersconsistsofthefollowing: 1. ValueatRiskMargin 2. ExtremeLossMargin 3. MarktoMarketMargin AllthreeMarginsarecollectedonthegrossopenpositionofthemember.Thegrossopen positionforthispurposemeansthegrossofallnetpositionsacrossalltheclientsofa memberincludingitsproprietaryposition. ValueatRiskMargin: AllsecuritiesareclassifiedintothreegroupsforthepurposeofVaRmargin

ForthesecuritieslistedinGroupI,scripwisedailyvolatilitycalculatedusingthe exponentiallyweightedmovingaveragemethodology.ThescripwisedailyVaRis3.5 timesthevolatilitysocalculatedsubjecttoaminimumof7.5%. ForthesecuritieslistedinGroupII,theVaRmarginishigherofscripVaR(3.5sigma) orthreetimestheindexVaR,anditisscaledupbyroot3. ForthesecuritieslistedinGroupIIItheVaRmarginisequaltofivetimestheindex VaRandscaledupbyroot3.

TheindexVaR,forthepurpose,isthehigherofthedailyIndexVaRbasedonS&PCNXNIFTY orBSESENSEX,subjecttoaminimumof5%. TheVaRmarginiscollectedonanupfrontbasisbyadjustingagainstthetotalliquidassetsof thememberatthetimeoftrade. TheVaRmarginsocollectedisreleasedoncompletionofpayinofthesettlement.

ExtremeLossMargin TheExtremeLossMarginforanysecurityishigherof: 1. 5%,or 2. 1.5timesthestandarddeviationofdailylogarithmicreturnsofthesecuritypricein thelastsixmonths.Thiscomputationisdoneattheendofeachmonthbytakingthe pricedataonarollingbasisforthepastsixmonthsandtheresultingvalueis applicableforthenextmonth. TheExtremeLossMarginiscollected/adjustedagainstthetotalliquidassetsofthemember onarealtimebasis. Thereisnonettingoffofpositionsacrossdifferentsettlements.TheExtremeLossMargin collectedisreleasedoncompletionofpayinofthesettlement MarktoMarketMargin Marktomarketlossiscalculatedbymarkingeachtransactioninsecuritytotheclosingprice ofthesecurityattheendoftrading.Incasethesecurityhasnotbeentradedonaparticular day,thelatestavailableclosingpriceatNSEisconsideredastheclosingprice.Incasethe netoutstandingpositioninanysecurityisnil,thedifferencebetweenthebuyandsellvalues shallbeisconsideredasnotionallossforthepurposeofcalculatingthemarktomarket marginpayable. Themarktomarketmargin(MTM)iscollectedfromthememberbeforethestartofthe tradingofthenextday. TheMTMmarginiscollected/adjustedfrom/againstthecash/cashequivalentcomponent oftheliquidnetworthdepositedwiththeExchange. TradeforTradesegmentSurveillancesegment IncaseofsecuritiesinTradeforTradeSurveillancesegment(TFTSsegment)theupfront marginrates(VaRMargin+ExtremeLossMargin)applicableis100%andeachtradeis markedtomarketbasedontheclosingpriceofthatsecurity. Cappingofmargins Incaseofabuytransaction,theVaRmargins,Extremelossmarginsandmarktomarket lossestogethercannotexceedthepurchasevalueofthetransaction.Incaseofasale transaction,theVaRmarginsandExtremelossmarginstogetherarecappedtotheextent ofthesalevalueofthetransactionandmarktomarketlossesarealsolevied. C) MarginsinF&OSegment

NSCCLhasdevelopedacomprehensiveriskcontainmentmechanismfortheFutures& Optionssegment.ThemostcriticalcomponentofariskcontainmentmechanismforNSCCL istheonlinepositionmonitoringandmarginingsystem.Theactualmarginingandposition monitoringisdoneonline,onanintradaybasis.NSCCLusestheSPAN(StandardPortfolio AnalysisofRisk)systemforthepurposeofmargining,whichisaportfoliobasedsystem. InitialMargin a.SpanMargin NSCCLcollectsinitialmarginupfrontforalltheopenpositionsofaCMbasedonthe marginscomputedbyNSCCLSPAN.ACMisinturnrequiredtocollecttheinitialmargin fromtheTMsandhisrespectiveclients.Similarly,aTMshouldcollectupfrontmarginsfrom hisclients. Initialmarginrequirementsarebasedon99%valueatriskoveraonedaytimehorizon. However,inthecaseoffuturescontracts(onindexorindividualsecurities),whereitmay notbepossibletocollectmarktomarketsettlementvalue,beforethecommencementof tradingonthenextday,theinitialmarginiscomputedoveratwodaytimehorizon, applyingtheappropriatestatisticalformula.ThemethodologyforcomputationofValueat RiskpercentageisaspertherecommendationsofSEBIfromtimetotime. Initialmarginrequirementforamember: Forclientpositionsisnettedatthelevelofindividualclientandgrossedacrossallclients, attheTrading/ClearingMemberlevel,withoutanysetoffsbetweenclients. ForproprietarypositionsisnettedatTrading/ClearingMemberlevelwithoutanysetoffs betweenclientandproprietarypositions. b.PremiumMargin InadditiontoSpanMargin,PremiumMarginischargedtomembers.Thepremiummarginis theclientwisepremiumamountpayablebythebuyeroftheoptionandisleviedtillthe completionofpayintowardsthepremiumsettlement. c.AssignmentMargin AssignmentMarginisleviedonaCMinadditiontoSPANmarginandPremiumMargin.Itis leviedonassignedpositionsofCMstowardsinterimandfinalexercisesettlement obligationsforoptioncontractsonindexandindividualsecuritiestillthepayintowards exercisesettlementiscomplete. TheAssignmentMarginisthenetexercisesettlementvaluepayablebyaClearingMember towardsinterimandfinalexercisesettlementandisdeductedfromtheeffectivedepositsof theClearingMemberavailabletowardsmargins.

 AssignmentmarginisreleasedtotheCMsforexercisesettlementpayin. InitialMarginrequirement=TotalSPANMarginRequirement+BuyPremium+Assignment Margin ExposureMargin Theexposuremarginsforoptionsandfuturescontractsonindexareasfollows: i.ForIndexoptionsandIndexfuturescontracts: 3%ofthenotionalvalueofafuturescontract.Incaseofoptionsitischargedonlyonshort positionsandis3%ofthenotionalvalueofopenpositions. ii.ForoptioncontractsandFuturesContractonindividualSecurities: Thehigherof5%or1.5standarddeviationofthenotionalvalueofgrossopenpositionin futuresonindividualsecuritiesandgrossshortopenpositionsinoptionsonindividual securitiesinaparticularunderlying. MTMMargin MTMmarginforF&OsegmentissameasthatofEquitysegment. D) PositionLimits ClearingMembersaresubjecttothefollowingpositionlimitsinadditiontoinitialmargins requirements.

MarketWidePositionLimits(forDerivativeContractsonUnderlyingStocks) TradingMemberwisePositionLimit ClientLevelPositionLimits FII/MFpositionlimits

MarketWidePositionLimits(forDerivativeContractsonUnderlyingStocks) AttheendofeachdaytheExchangedisseminatestheaggregateopeninterestacrossall Exchangesinthefuturesandoptionsonindividualscripsalongwiththemarketwide positionlimitforthatscripandtestswhethertheaggregateopeninterestforanyscrip exceeds95%ofthemarketwidepositionlimitforthatscrip.Ifyes,theExchangetakesnote ofopenpositionsofallclient/TMsasattheendofthatdayinthatscrip,andfromnextday onwardstheclient/TMsshouldtradeonlytodecreasetheirpositionsthroughoffsetting positionstillthenormaltradinginthescripisresumed. Thenormaltradinginthescripisresumedonlyaftertheaggregateopeninterestacross Exchangescomesdownto80%orbelowofthemarketwidepositionlimit.

Afacilityisavailableonthetradingsystemtodisplayanalertoncetheopeninterestonthe NSEinthefuturesandoptionscontractinasecurityexceeds60%ofthemarketwide positionlimitspecifiedforsuchsecurity.Suchalertsarepresentlydisplayedattimeintervals of10minutes. TradingMemberwisePositionLimit Thetradingmemberwisepositionlimitinequityindexoptionandindexfuturesisasunder: IndexFutures ThetradingmemberpositionlimitsinequityindexfuturescontractsishigherofRs.500 croresor15%ofthetotalopeninterestinthemarketinequityindexfuturescontracts.This limitisapplicableonopenpositionsinallfuturescontractsonaparticularunderlyingindex. IndexOptions ThetradingmemberpositionlimitsinequityindexoptioncontractsishigherofRs.500 croresor15%ofthetotalopeninterestinthemarketinequityindexoptioncontracts.This limitwouldbeapplicableonopenpositionsinalloptioncontractsonaparticularunderlying index FuturesandOptioncontractsonindividualsecurities: Thetradingmemberwisepositionlimitinfuturesandoptionsinindividualstocksisrelated tothemarketwidepositionlimitfortheindividualstocks. i.Forstockshavingapplicablemarketwidepositionlimit(MWPL)ofRs.500croresormore, thecombinedfuturesandoptionspositionlimitis20%ofapplicableMWPLorRs.300 crores,whicheverislowerandwithinwhichstockfuturespositioncannotexceed10%of applicableMWPLorRs.150crores,whicheverislower. ii.Forstockshavingapplicablemarketwidepositionlimit(MWPL)lessthanRs.500crores, thecombinedfuturesandoptionspositionlimitis20%ofapplicableMWPLandfutures positioncannotexceed20%ofapplicableMWPLorRs.50crorewhicheverislower. ClientLevelPositionLimits Thegrossopenpositionforeachclient,acrossallthederivativecontractsonaunderlying, shouldnotexceed: 1%ofthefreefloatmarketcapitalization(intermsofnumberofshares)or 5%oftheopeninterestinallderivativecontractsinthesameunderlyingstock(intermsof numberofshares) whicheverishigher Clientlevelpositionlimitsunderlyingwise,areavailabletomembersonNSE'swebsite. E) Violations

PRISM(ParallelRiskManagementSystem)istherealtimepositionmonitoringandrisk managementsystemfortheFuturesandOptionsmarketsegmentatNSCCL.Theriskofeach tradingandclearingmemberismonitoredonarealtimebasisandalerts/disablement messagesaregeneratedifthemembercrossesthesetlimits.

InitialMarginViolation ExposureLimitViolation TradingMemberwisePositionLimitViolation ClientLevelPositionLimitViolation MarketWidePositionLimitViolation Violationarisingoutofmisutilisationoftradingmember/constituentcollaterals and/ordeposits ViolationofExercisedPositions

Clearingmembers,whohaveviolatedanyrequirementand/orlimits,mayreducethe positionbyclosingoutitsexistingpositionor,bringinadditionalcashdepositbywayof cashorbankguaranteeorFDRorsecurities.Similarly,incaseofmarginviolationbyTrading members,clearingmemberhastosetitslimitforenablement. InitialMarginviolation TheinitialmarginonpositionsofaCMiscomputedonarealtimebasisi.e.foreachtrade. TheinitialmarginamountisreducedfromtheeffectivedepositsoftheCMwiththeClearing Corporation.Forthispurpose,effectivedepositsarecomputedbyreducingthetotal depositsoftheCMbyRs.50lakhs(referredtoasminimumliquidnetworth).TheCM receiveswarningmessagesonhisterminalwhen70%,80%,and90%oftheeffective depositsareutilised.At100%theclearingfacilityprovidedtotheCMiswithdrawn. WithdrawalofclearingfacilityofaCMincaseofaviolationwillleadtowithdrawalof tradingfacilityforallTMsand/orcustodialparticipantsclearingandsettlingthroughthe CM. Similarly,theinitialmarginsonpositionstakenbyaTMarecomputedonarealtimebasis andcomparedwiththeTMlimitssetbyhisCM.Theinitialmarginamountisreducedfrom theTMlimitsetbytheCM.OncetheTMlimithasbeenutilisedtotheextentof70%,80%, and90%,awarningmessageisreceivedbytheTMonhisterminal.At100%utilization,the tradingfacilityprovidedtotheTMiswithdrawn. Amemberisprovidedwithwarningsat70%,80%and90%levelbeforehistrading/clearing facilityiswithdrawn.ACMmaythusaccordinglyreducehisexposuretocontainthe violationoralternatelybringinAdditionalBaseCapital. ExposureLimitViolation ThisviolationoccurswhentheexposuremarginofaClearingMemberexceedshisliquid networth,atanytime,includingduringtradinghours.Theliquidnetworthmeansthe effectivedepositsasreducedbyinitialmarginandnetbuypremium.Incaseofviolation,the clearingfacilityoftheclearingmemberiswithdrawnleadingtowithdrawalofthetrading

facilitiesofalltradingmembersand/orclearingfacilityofcustodialparticipantsclearing throughtheclearingmember. TradingMemberwisePositionLimitViolation Thisviolationoccurswhentheopenpositionofthetradingmember/custodialparticipant exceedstheTradingMemberwisePositionLimitatanytime,includingduringtradinghours. Incaseofviolationthetradingfacilityofthetradingmemberiswithdrawn. Inrespectofinitialmarginviolation,exposuremarginviolationandpositionlimitviolation, penaltyisleviedonamonthlybasisbasedonslabsasmentionedbelow. ClientLevelPositionLimitViolation Thisoccurswhentheopenpositionofanyclientexceedstheclientwidepositonlimit TheTM/CMthroughwhomtheclienttrades/clearshisdealsisliableforsuchviolation. Intheeventofsuchaviolation,TM/CMshouldimmediatelyensure, (i)thattheclientdoesnottakefreshpositionsand (ii)reducesthepositionsofsuchclientstobewithinpermissiblelimits. Additionally,intheeventofsuchaviolation,penaltywouldbechargedtoClearing Membersforeverydayofviolation. 1%ofthevalueofthequantityinviolation(i.e.,excessquantityovertheallowedquantity, valuedattheclosingpriceoftheunderlyingstock)perclientor Rs.1,00,000perclient,whicheverislower,subjecttoaminimumpenaltyofRs.5,000/per violation/perclient.whentheclientlevelviolationisonaccountofopenpositionofclient exceeding5%ofopeninterest,apenaltyofRs.5,000/perinstanceischargedtoclearing member. TheClearingMembercanrecoverthepenaltysochargedfromtherespectiveTrading Member/Clientviolatingtherequirementofpositionlimitsandincaseswhereitislevied andcollectedfromTradingMember,suchtradingmember,inturn,canrecoverthesame fromtherespectiveclientswhoviolatedthepositionlimits. DisclosureforClientPositionsinIndexbasedcontracts Anypersonorpersonsactinginconcertwhotogetherown15%ormoreoftheopen interestonaparticularunderlyingindexisrequiredtoreportthisfacttotheExchange/ ClearingCorporation.Failuretodosoistreatedasaviolationandattractsappropriatepenal anddisciplinaryactioninaccordancewiththeRules,ByelawsandRegulationsofthe ClearingCorporation. Forfuturescontracts,openinterestisequivalenttotheopenpositionsinthefutures contractmultipliedbylastavailabletradedpriceorclosingprice,asthecasemaybe.For optioncontracts,openinterestisequivalenttothenotionalvaluewhichiscomputedby multiplyingtheopenpositioninthatoptioncontractwiththelastavailableclosingpriceof

theunderlying. MarketWidePositionLimitsforderivativecontractsonunderlyingstocks Attheendofeachdayduringwhichthebanonfreshpositionsisinforceforanyscrip,when anymemberorclienthasincreasedhisexistingpositionsorhascreatedanewpositionin thatscriptheclient/TMsarechargedapenalty. Thepenaltyisrecoveredfromtheclearingmemberaffiliatedwithsuchtrading members/clientsonaT+1daybasisalongwithpayin.Theamountofpenaltyisinformedto theclearingmemberattheendoftheday.. Violationarisingoutofmisutilisationoftradingmember/constituentcollateralsand/or deposits ThisviolationtakesplacewhenaclearingmemberutilisesthecollateralofoneTMand/or constituenttowardstheexposureand/orobligationsaTM/constituent,otherthanthe sameTMand/orconstituent. ViolationofExercisedPositions WhenoptioncontractsareexercisedbyaCM,wherenoopenlongpositionsforsuchCM/ TMand/orconstituentexistattheendoftheday,atthetimetheexerciseprocessingis carriedout,itistermedasviolationofexercisedpositions.