All the ITM f&o are supposed to be settled by delivering physical underlying scrip.
I just came to know about “Do-not-exercise” but couldn’t get much authentic information about it.
Could you please enlighten me on this?
yes all stocks ITM options can be settled physically… or you can also square off it before expiration…
Now, let say you are long in a ITM put and you decided to exercise it… So according to the rule you need to sell the underlying scrip at the strike price… But if you don’t have the share of underlying scrip then how you gonna settle the contract with out selling the shares… So there is a problem of “short delivery”.
This post on Z-Connect explains about the Do Not Exercise option -
Policy regarding Close to Money contracts (CTM)
Exchanges have provided an option to not exercise long CTM contracts. We will be using this option on expiry day in case the cash balance and the intrinsic value of the option contract is less than twice the SPAN+Exposure margin (Exchange mandated) required to take a position in the futures contract of the same stock for the current expiry.
For example: If you are long 1 lot of WIPRO Oct 19 240 CE and let it expire and WIPRO(Stock) settles at Rs. 243, this contract will be a CTM contract. The intrinsic value of this contract will be 3 [243-240] x 3200(lot size) = Rs 9600.
Post-market closing we will check if the client’s free balance (Cash balance + Rs 9,600) > Rs 3,11,040 ( 40% of the contract value or twice the SPAN +Exposure margin for WIPRO Oct future contract). If client balance is lesser than Rs 3,11,040, this position will be marked as “Do not exercise” and the option contract will expire worthless. If the balance is more than the required margin, we will let the option be exercised, resulting in physical delivery. All costs arising out of such delivery obligations will be applied to the client’s account.
Also, refer to this thread. In case you are interested, you can also refer to the circular issued by NSE about this matter.
Even though Zerodha has a policy to automatically assign Do Not Exercise to CTM strikes if the client doesn’t have enough funds available, this might not be the case with other brokers. You may have to explicitly inform the other brokers that you wish to use the Do-Not-Exercise option for your CTM strikes.
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So as per this, if I don’t have enough money to take physical delivery (in case of being long), my ITM option will expire worthless. Right?
What about if I’m short? And what about the counter party if the paid premium is greater then difference (ie: I bought 1 lot of wipro 240 at 6 rs premium and it expires at 243) For me it will expire worth less but what will happen at seller side?
Not so used with this. For exercise option features, the option holder has the right to buy and sell but there is no obligation. I guess it’s the opposite for the do not exercise options feature.
Yes. From what I understand, the CTM strikes which utilize Do-Not-Exercise will act like OTM strikes if one doesn’t have enough funds available in the account.
Due to Do-not-Exercise, the option seller will pocket the option premium and will no longer have the obligation to physically settle the contract. But given that the option exercise process is random in nature, no option seller of CTM strikes can be certain if they will have the obligation or not until the final settlement (as there might be some options buyers of CTM strikes who would have funds and would be looking to exercise their options)