Introduction to trading systems

Objectives:
Trading system for future and options
Different entities in the trading system
Different types of orders in the trading system and order matching rule
Selection criteria of stocks and index for futures and option trading
Position limits for equity derivatives

Trading system:
We shall take a brief look at the trading system of futures and options on exchanges,
including various types of orders.
As stated earlier, futures and options are standardized contracts and like shares, they are
traded on exchanges. Markets around the world can be classified into two main types based
on the methods of booking a trade namely an “open outcry” market and the “electronic “
market. Open outcry is the way of communication between professionals on an exchange,
which involves shouting, or using hand signals to transfer information about buy and sell
orders. In an open outcry markets, usually the trading takes place in a large hall known as
“pit” where members are present and contracts are traded through continuous bids and offers.
Thus , such a market brings together the buyers and sellers(through their brokers) on a
platform for trading. In case of electronic trading, there are screen based broker dealing
terminals, instead of the trading pit. Futures and options trading in India is electronic in
nature, with the bids and offers, and the acceptance being displayed on the terminal
continuously.
All the exchanges in India (BSE, NSE and MSEI) provide a fully automated screen- based
trading platform for index futures, index options, stock futures and stock options. These
trading systems supports an order driven market and simultaneously provide complete
transparency of trading operations. The trading of equities in the cash market segment.
Entities in the trading system
Broadly there are four entities in the trading system
 Trading members
 Trading cum clearing members(TM-CM)
 Professional clearing members (PCM)
 Self clearing member (SCM)
 Participants
Trading members:
They are members of stock exchanges. They can trade either on behalf of their clients or
on their own account. The exchange assigns a trading members ID to each of its trading
member. A trading member can have more than one user.
 The number of users allowed for each trading member is decided by the exchange from
time to time. A user must be registered with the exchange where he is assigned a unique
user ID.
The unique trading member ID is common for all the users of a particular trading
member. Therefore, it functions as a reference for all users of a particular trading
member. Trading member is responsible to maintain adequate control over persons
having access to the firm’s users IDs.

Trading cum clearing members:

A clearing member (CM) who is also a trading member (TM) of the exchange. Such CMs
may clear and settle their own proprietary trades, their client’s trades as well as trades of
other TMs &custodial participants.

Professional clearing member:

Professional clearing member clears the trades of his associate Trading member
institutional clients. PCM is not a trading member of the exchange. Typically bans or
custodians become a PCM and clear and settle for TM’s as well as for custodial
participants.

Participants:
participants is a client of a trading member. Clients may trade through various trading
members but settled through a single clearing member
Market timing of derivative settlement:
Trading on the derivatives segment takes place on all working days of the week between
9:15a.m and 3:30 p.m.
Corporate hierarchy:
In the futures and options trading software, trading member will have a provision of defining
the hierarchy amongst users of the system. This hierarchy comprises:
 Corporate manager
 Branch manager and
 Dealer
Corporate manager:
As a user, it is the highest level in a trading firm. Corporate manager can perform all
the functions such as order and traded related activities, receiving reports for all
branches of the trading member firm an also all dealers of the firm. Along with this he
can also define exposure limits for the branches of the firm. This facility is available
only to the corporate manager.
Branch manager:
As a user it is placed under the corporate manager. Branch manager can perform and
view order and trade related activities for all dealers under that branch.
Dealer:
 Dealer is at the lowest level of the user hierarchy. He can only view his own orders
and trades and does not have access to information on other dealers under either the
same branch or in other branches.
Client broker relationship:
A trading member would be responsible for various compliance related activities
including know your client (KYC) form, execution of client broker agreement, timely
execution of orders given by clients, collection of adequate margins, maintain
separate client bank account for segregation of client money, ensure timely pay-in and
pay-out of funds, timely issue of contract notes, resolve client’s complaints, sending
periodical statement of accounts, maintain unique client code, etc.
Order types and conditions:
In the trading system, trading members are allowed to enter orders with various
conditions attached to them as per their requirements. These conditions are broadly
divided into the following categories:
 Time conditions
 Price conditions
 Various combinations of the above are allowed providing flexibility to the users.

Time conditions:
Day order: A day order is an order which is valid for a single day on which it is
entered. If the order is not executed during the day, the trading system cancels the
order automatically at the end of the day.
Immediate or cancel (IOC): user is allow to buy/ sell a contract as soon as the order
is released into the trading system. An unmatched order will be immediately
cancelled. Partial order match is possible in these orders, and the unmatched portion
of order is cancelled immediately.

Price condition:
Limit order: it is an order to buy or sell a contract at a specified price. The user has
to specify these limit price while placing the order and the order gets executed only at
these specified limit price or at a better price the (lower in case of buy order and
higher in a case of sell order).
Market order: a market order is an order to buy or sell a contract at the best bid/
offer price currently available in the market. Price is not specified at the time of
placing this order. The price will be the currently available price in the market i.e. a
buy market order will get executed at the best price at which the seller is ready to sell
and sell market order will get executed at the best price at which the buyer is ready to
buy.
claimed above (or dropped below) a trigger price. The stop- loss order gets activated when
the trigger price is reached/ crossed an enters the market as a market order or as a limit order,
as defined at the time of placing these stop-loss order. To illustrate, suppose a trader buys
ABC ltd. Shares at Rs.100 in expectation that the price will rise. However, prices start
declining below his buy price, trader wood like to limit his losses. Trader may place a limit
sell order specifying a trigger price of Rs.95 and a limit price of Rs.92. the trigger price has to
 be between last traded price and limit price. While planning the sell limit order. Ones the
market price of ABC branches the trigger price i.e., Rs 95, the order gets converted to a limit
sell order at Rs.92. (trigger price is the price at which the order gets triggered from the stop
loss book.)

Order Matching Rules:

In India, F&O platforms offers an order driven market, wherein order math
automatically on price time priority basis.
Oder’s, as and when they are received, are first time stamped and then immediately
processed for potential match. If a match is not found, then the orders are stored in
different ‘books’. Orders are stored in price-time priority in various books in the
following sequence:

 .Best price
 with in price, by time priority.
The best buy order will math with the best sell order.an order may match partially with another order
resulting in multiple trades. For order matching, the best buy order is the one with highest price and
the best sell order is the one with lowest price. This is because the computer views all buy orders
available from the point of view of seller and all sell orders from the point of view of the buyers in the
market.

Price Band:
There are no price bands applicable in the derivatives segment