Physical Settlement in Stock Derivatives from October 2019 expires

Listen to this article

The Indian derivatives market is considered one of the most speculative in the world.

The ratio of cash market turnover to derivative market turnover, recorded in recent times in the Indian Capital market, has been the highest in the world.

To curb excessive speculation, which creates too much volatility in the market, SEBI initiated physical settlement of stocks trading in the derivatives segment, on expiry of the contract.

From this month expiry, i.e. October 2019 onwards, traders will have to compulsorily take delivery of shares on the expiry day against their open derivatives positions, including in the money options.

Out of the 150 stocks traded in the futures and options segment, the physical settlement mechanism already applies to 105 stocks. With the market regulator’s new mandate, from Sept. 27, or the start of October series, the remaining 45 stocks—highly liquid and most traded in the F&O segment—will also be delivered physically at the end of expiry, unless squared off or rolled over to next month.

What does Physical settlement in derivatives mean?

Earlier, on the expiry date of a contract, any open stock position in the F&O segment would automatically get squared-off by the exchanges at the close of the session. The final closing price would become the settlement price and the difference between the trader’s position and the settlement price either got debited or credited, as the case may be, into his or her ledger.

Now, if a trader doesn’t square-off  positions in the identified stocks before the close of trading hours on the expiry day, he or she will either have to take delivery (for long futures, long in the money calls, short in the money puts) or give delivery of the underlying stock (short futures, long in the money puts, short in the money calls) as per the contract.

 Some illustrations

1. Purchase of shares: Let’s assume that you are bullish on Reliance Industries and have purchased one lot (i.e. 500 shares). Suppose the stock was closed at Rs.1300 on the expiry day, you will have to pay Rs.6,50,000 (Rs.1300 * 500 shares) and take physical delivery, if you have not sold off your position prior to expiry.

2. Purchasing Calls: If you have purchased one lot on Reliance 1250 Call option and on the expiry day the shares of Reliance Industries close above the Call strike price of 1250, at say Rs.1252, you have to pay Rs.6,26,000 and take delivery of one lot of Reliance Industries (Rs.1252 * 500 shares), if your position is not squared off before expiry.

3. Selling of shares: Similarly, if you are bearish on Reliance Industries and sold one lot, you have to give delivery of 500 shares of the stock, if your position is not closed ahead of expiry.

4. Purchasing Puts: If you purchased one lot on Reliance 1250 Put option and on expiry day the shares of Reliance Industries close below the Put strike price of 1250, at say Rs.1249, you will have to give delivery of one lot of Reliance Industries (i.e. 500 shares), if your position was not squared off before expiry.

In-the –Money Call Options

1. Long Calls exercised will result in buy (security receivable) positions

2. Short Calls assigned result in sell (security deliverable) positions

In –the –Money Put Options

1. Long Puts exercised result in sell (security deliverable) positions

2. Short Puts assigned result in buy (security receivable) positions

When will the delivery be effected?

The physical settlement will be settled on Expiry+2 days.

What margins will be levied?

Post expiry, positions which are converted to physical settlement, margins as applicable in the capital market segment (i.e. VAR, Extreme Loss Margins, and Mark to Market margins) will be applicable and levied as delivery margins.

What happens on failure to deliver?

Failure of the seller to deliver securities shall result in buy-in-auction for the shares by Clearing Corporation as per auction schedule declared periodically. Currently auctions will be conducted on Expiry+3 days and settled on Expiry+4 days. The auction amount will be charged in case of short delivery of shares. Failure to procure shares in the auction will be closed out.

Takeaway tips

Under this new system, F&O traders wishing to benefit from the leverage of the F&O market should have a clear strategy before entering into any position. Besides, proper communication with your broker becomes a must, especially during the expiry week.

You May Also Like: Stocks and Sectors that benefit from the Corporate Tax rate cut

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

3 comments

Leave a Reply