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Why is the option order being rejected with a request to place it around the theoretical price?

Brokers are required by the exchanges (PDF) to have risk management checks that ensure freak trades in options don’t occur at prices significantly away from the theoretical prices. These trades are sometimes also referred to as freak trades.

Example scenario

Assume a stock is trading at ₹95 and the Call option of the 100 Strike is traded at ₹5. If there were a buy trade at ₹50 while the stock is still trading at ₹95, this trade would be away from the theoretical price.

Such freak trades disrupt price discovery, and traders also incur huge losses. These freak trades can either be:

  • Accidental

Traders sometimes can unwittingly place large orders than intended.

  • Intentional

Fraudulent actors with access to someone’s trading account can move money from one account to another by creating artificial losses. They do this by buying an illiquid option contract much higher than the theoretical price and reversing the trade at a lower price.

To ensure that Zerodha’s customers are protected from these freak trades, placing orders in an option contract is allowed only within a range from the theoretical price of the contract. Zerodha also doesn’t allow market orders in illiquid index options and stock option contracts. Exchanges have stopped supporting Stop Loss Market [SL-M] orders for option contracts for the same reason.

Ensure that orders aren’t mistakenly placed in the wrong option contract and are placed closer to the theoretical price if this error is displayed.

Did you know? An order can still be placed outside the theoretical range set by Zerodha using a long-standing order type called Good Till Triggered (GTT). But when the GTT is triggered, the above theoretical range checks will be applied, and the order will be rejected if it is outside the range. To learn more about GTT, see What is the Good Till Triggered (GTT) feature?