How does the new physical settlement of stock derivatives work?

[satyabrata_swain]

So the RCOM 20 CE will expire @5 paise and no physical delivery required on 25th october?

[siva]

@satyabrata_swain

So the RCOM 20 CE will expire @5 paise and no physical delivery required on 25th october?

It should expire at 0, please read option module before placing another options trade.

[Newbie420]

Hi Siva, i remember reading a post by someone that Zerodha will keep the updated list of physical settlement stocks somewhere on the website?

Is it done or being done?

[MohammedFaisal]

Yes!

List Of Scrips - Physical delivery settlement

[trader29]

@nithin

1. How do an option buyer invokes his ‘Do Not Excercise’ Right for ITM options?

2. Lets say option buyer let the stock option excercise, BUT Doesn’t have required full security value of the contract, also the stock option is illiquid, no buyers on expiry day! so broker is unable to auto-squareoff. how does that pan out?

3. Lets say I am a stock option buyer and a stock option is excercised and funds are debited at 2:00 PM, is the account is earmarked for delivery the same day like normal equity and recieve the security after T+2 days, in that case can we sell off the security received(from earmarked account) under BTST on the particular scrip? As we are an option buyer and as all FnO scrips will be in ‘EQ’ series we should be able to do that right?

[nithin]

@trader29

• How do an option buyer invokes his ‘Do Not Excercise’ Right for ITM options?

• Lets say option buyer let the stock option excercise, BUT Doesn’t have required full security value of the contract, also the stock option is illiquid, no buyers on expiry day! so broker is unable to auto-squareoff. how does that pan out?

• Lets say I am a stock option buyer and a stock option is excercised and funds are debited at 2:00 PM, is the account is earmarked for delivery the same day like normal equity and recieve the security after T+2 days, in that case can we sell off the security received(from earmarked account) under BTST on the particular scrip? As we are an option buyer and as all FnO scrips will be in ‘EQ’ series we should be able to do that right?

1. An option buyer cannot and not on all ITM strikes. Exchanges allow options that are expiring just ITM (where STT is more than the intrinsic value) to not be exercised. Check this post
   NO MORE STT trap on exercised In the money options

2. Depends on what option. If they are calls, there is a forced delivery to your account. If you don’t have the money, the account goes into debit and interest charged on the debit until the stock received can be sold. If puts, a lot more painful. You have to give delivery, but if you don’t have stock, the trade goes to auction and stock bought at auction price and delivered. Check out this post on short delivery.
   Consequences of Short delivery - NSE/BSE – Z-Connect by Zerodha

3. At Zerodha we ask for extra margin for long options 3 days before expiry as delivery margin. Some brokers ask you to square off all long options the previous Thursday itself, even if you have the money. Stocks that are received through exercise, are like normal delivery trades. So comes to your demat on T+2 after expiry. No, you cannot do BTST, you will have to wait for delivery before selling.

[Prakhar_Agrawal]

The definition of option states that option gives the buyer the right but not an obligation to buy or sell the securities at some point on future.
Therefore when an option contracts is a right for option buyer but not his obligation then why should he forced to exercise even in the money option also if he don’t want to.

[nithin]

@Prakhar_Agrawal

The definition of option states that option gives the buyer the right but not an obligation to buy or sell the securities at some point on future.
Therefore when an option contracts is a right for option buyer but not his obligation then why should he forced to exercise even in the money option also if he don’t want to.

Options are contracts through which a seller gives a buyer the right, but not the obligation, to buy or sell a specified number of shares at a predetermined price within a set time period.

Set time period is essentially until expiry. Post expiry the options have to be settled - either cash or through physical delivery or else just let it all expire worthless even if in the money. Exchanges now give that option to expire it worthless for just ITM options to protect from STT issue. The reason for moving from cash to physical delivery is to reduce any price manipulation that might be happening through options, and settling through physical delivery is quite a common thing around the world.

How price manipulation, have explained here

How does the new physical settlement of stock derivatives work?

Here is one of the reasoning behind this SEBI move. Today if you are an operator with access to unlimited amounts of cash/stock, you can keep shorting/buying F&O contracts to move the stock in a particular direction without having to worry about placing a counter trade. So assume a stock with lot size of 5000 is at Rs 100. An operator can keep selling futures/shorting calls to move the price down of this stock. On the expiry day, since everything is cash settled, he doesn’t have to worry about…

[siva]

@Prakhar_Agrawal

The definition of option states that option gives the buyer the right but not an obligation to buy or sell the securities at some point on future.
Therefore when an option contracts is a right for option buyer but not his obligation then why should he forced to exercise even in the money option also if he don’t want to.

Adding to above,
Compulsory Settlement only if it expires ITM, ITM in this case is defined as immediate 3 strikes below settlement price for calls and vice-versa for puts.
Also ITM covers upto 5% of moneyness, why would anyone want to leave that money in their right senses?
Also this is an regulatory rule which one has to adhere to.

[Ddude]

A bit confused. I am short both CE 1280 and CE 1300 Kotak. Are they both considered ITM and will both be definitely squared off either today or before expiry 28 Feb considering Kotak is trading around 1245?

Please clarify. Thanks.

[siva]

@Ddude

A bit confused. I am short both CE 1280 and CE 1300 Kotak. Are they both considered ITM and will both be definitely squared off either today or before expiry 28 Feb considering Kotak is trading around 1245?

I would recommend you to go through varsity here before putting another options trade because of the query you have. Currently they are OTM options and square off will happen only for margin shortfall from your broker side.
Also check https://sensibull.com/, go through videos and all.

[Ddude]

Thanks for the reply Siva.

I understand how options work for most part. My only confusion stems from the new F&O rules that have cropped up regarding physical settlements. Maybe I did not ask my query clearly. Let me rephrase it. I am short both Call 1280 and Call 1300 on Kotak Bank. Currently it is trading around 1242. Assuming no shortfall in terms of margins, then at what price will Zerodha look to square off (to avoid physical settlement) during the last week of expiry?

Thanks

[MohammedFaisal]

Let me explain 2 scenarios on Expiry day:

1. Kotak Bank remains below 1280- Both options remain OTM, no physical delivery obligation.
2. KotakBank is trading above 1280- Your 1280 CE is ITM(1300 CE will also be ITM if Kotak is above 1300). There will be give delivery obligation and you need to hold stocks equal to the lot size in your demat account. Your position will be squared-off otherwise.

[Ddude]

Thanks Mohd Faisal for quick reply. Just few more follow-up questions.

Let’s assume that I am short 1280 CALL on Kotak

1a) Kotak trades at 1275. (Non Covered CALL) Despite Kotak is trading closer to the strike, Zerodha will NOT square-off during the expiry day or earlier as long as sufficient span+exposure margin is maintained. Correct?

1b) Kotak trades above 1280 (say around 1320) but I hold equivalent stocks in my demat. Zerodha will not square-off on expiry day or earlier as I can meet delivery obligations. Correct?

Now let’s assume that I am short 1280 PUT on Kotak

2a) Kotak trades at 1285. (OTM) Despite Kotak trades closer to the Strike, Zerodha will not square-off on expiry day or earlier as long as sufficient span+exposure margin is maintained. Correct?

2b) Kotak trades at 1275 (ITM). Though I don’t have sufficient balance in my demat account to pay for stocks, I have sufficient margin balance to meet span+exposure margin requirements. Will Zerodha square-off ONLY on expiry day (Thurs) or can it even do it earlier during expiry week as soon as the Naked PUT becomes ITM? Pls clarify.

Thanks in Advance

[MohammedFaisal]

@Ddude

1a) Kotak trades at 1275. (Non Covered CALL) Despite Kotak is trading closer to the strike, Zerodha will NOT square-off during the expiry day or earlier as long as sufficient span+exposure margin is maintained. Correct?

If the scrip is trading to close to the strike, the decision to square-off will be at the discretion of our RMS team as you don’t hold the deliverable quantity in your demat a/c. It is ideal you do not take this risk as the cost of auction settlement is high if your position turns ITM and cannot be squared-off.

@Ddude

1b) Kotak trades above 1280 (say around 1320) but I hold equivalent stocks in my demat. Zerodha will not square-off on expiry day or earlier as I can meet delivery obligations. Correct?

No, as long as you hold the quantity in your demat and you comply with the margin requirements, your position won’t be squared-off

@Ddude

2a) Kotak trades at 1285. (OTM) Despite Kotak trades closer to the Strike, Zerodha will not square-off on expiry day or earlier as long as sufficient span+exposure margin is maintained. Correct?

Correct

@Ddude

2b) Kotak trades at 1275 (ITM). Though I don’t have sufficient balance in my demat account to pay for stocks, I have sufficient margin balance to meet span+exposure margin requirements. Will Zerodha square-off ONLY on expiry day (Thurs) or can it even do it earlier during expiry week as soon as the Naked PUT becomes ITM? Pls clarify.

We increase the margin requirements starting from Expiry minus 4 days up to 80% of contract value on expiry(Which is higher than SPAN+Exposure). If you fail to maintain these margins, your position can be squared-off any day during the week after a margin call is given to your through Email/SMS.

[Ddude]

Thanks Mohd Faisal.

Is the increase in margin requirements starting from Expiry minus 4 days upto 80% of contract value mandated only for ITM or even OTM / Near TM ?

[MohammedFaisal]

For option short positions, both ITM/OTM.
For option long positions, only ITM.

[vamsiogl1]

Hi…

If I have enough funds in my trading account to hold a short call till expiry and if the same ends up as OTM(which is worthless) it will still be cash settled like before. Correct?

Lets say I hold Hexaware 400 CE and stock price is at 350 around and assume that I shorted Hexaware 400 CE at 3/-… I will get 1500 x 3 = 4500 into my account. Correct?

All these physical settlement rules are applicable only for ITM and nearest ITM calls which are vulnerable/prone to be exercised by buyers. Correct?

[Sumsam]

SEBI New margin guidelines are to come to effect from the 1st of June and will benefit hedged positions. The margin requirement for all Stock F&O contracts increases 2 days prior to expiry (Wednesday and Thursday of the expiry week) to twice of the exchange mandated SPAN + Exposure margin required.
Is this likely to continue as before? Also is there any change in physical delivery margin for ITM long options

[siva]

@Sumsam

The margin requirement for all Stock F&O contracts increases 2 days prior to expiry (Wednesday and Thursday of the expiry week) to twice of the exchange mandated SPAN + Exposure margin required.
Is this likely to continue as before? Also is there any change in physical delivery margin for ITM long options

They will remain same, if any changes to this, we will update all our clients.