Will Zerodha square off the positions in case of “freak trades”?

[ron94]

I request zerodha to clarify some additional details on this question. This is the answer given on the zerodha support page :
“No, Zerodha won’t square off the positions in case of a freak trade since the freak trade lasts for a fraction of a second before it reverts to the regular trading price. So traders may have a higher unrealised loss only for that fraction of a second.”

Question 1) If I have a naked OTM option and there is a large spike due to a freak trade or low liquidity. EG: SOLD PE OTM option goes from 5 to 500 and this results in MTM Loss that taken the margin to negative. THEN what will zerodha do in the fillowing scenarios:
A) Margin is negative by <10% of funds and spike lasts less than 10 seconds
B) Margin is negative by >10% of funds and spike lasts less than 10 seconds
C) Margin is negative by between 20% to 50% of funds and spike lasts less than 10 seconds
d) Margin is negative by >50% of funds and spike lasts less than 10 seconds

Question 2) What if the same scenario occurs but the spike lasts longer (say between 10 to 30 seconds)?
Question 3) What if the spike lasts more than 30 seconds?

Second Scenario what if the SOLD OTM PE option is hedged in a 1:1 ratio and the loss is capped, however, due to illiquidity of the hedge, the premium of the hedge does not increase as quickly as the sold position thereby resulting in a large MTM LOSS? Then what would zerodha do in scenarios A,B,C,D? For the above questions I am referring to INDEX options.
Request someone from zerodha to reply in detail because many people have these questions in mind.

[Meher_Smaran]

Hi @ron94

As confirmed by the RMS team,

@ron94

Question 1) If I have a naked OTM option and there is a large spike due to a freak trade or low liquidity. EG: SOLD PE OTM option goes from 5 to 500 and this results in MTM Loss that taken the margin to negative. THEN what will zerodha do in the fillowing scenarios:
A) Margin is negative by <10% of funds and spike lasts less than 10 seconds
B) Margin is negative by >10% of funds and spike lasts less than 10 seconds
C) Margin is negative by between 20% to 50% of funds and spike lasts less than 10 seconds
d) Margin is negative by >50% of funds and spike lasts less than 10 seconds

Question 2) What if the same scenario occurs but the spike lasts longer (say between 10 to 30 seconds)?

For any freak trades that last below 10 seconds up to 30 seconds, We won’t square off as in 99.99% of cases, prices will come back to normal levels

@ron94

Question 3) What if the spike lasts more than 30 seconds?

The general rule is that for freak trades we won’t do any square-offs, but if the trades are happening actively at the higher prices for more than 15 minutes and MTM loss crosses 70% of your capital, then we take the action

@ron94

Second Scenario what if the SOLD OTM PE option is hedged in a 1:1 ratio and the loss is capped, however, due to illiquidity of the hedge, the premium of the hedge does not increase as quickly as the sold position thereby resulting in a large MTM LOSS? Then what would zerodha do in scenarios A,B,C,D? For the above questions I am referring to INDEX options.

In the case of hedged positions, As long as clients have sufficient exchange-specified margin till the next day morning, We won’t square off any positions as loss in the short leg will be compensated by profit in the hedge.