Mismatch between actual premium price & what it should be on Expiry

General
1

I noticed that in Options that close far In The Money (ITM), do not have accurate premium price on expiry.
For example if the Nifty price on close is 17000 , then say a strike price like 16000 should have a premium of Rs 1000 (Market price - Strike Price) at Expiry. But most likely it may show much higher or lower on the NSE Options chain at close. This completely puts all calculations into disarray.
Is this what is it (we got to live with this aberration) or in actual it is settled at the accurate price and the NSE Option chain is not accurate ?

I will give one more example. Say if I sell 16500 (put) for Rs 310 and and buy 16450 (put) for Rs 280, then I am getting a credit of Rs 30. And if Nifty closes at 16000 then I should be having a maximum transactional loss of Rs 50 (the difference between two strike prices). And my eventual total loss should not be more than Rs 20 (ie. Rs 50 loss - Rs 30 Premium). But in actual can be more than Rs 20 … why so ?

I will mention the above (credit spread) in a table form

SELL - 16500 (PE) - Premium received - Rs 310
BUY - 16450 (PE) - Premium paid - Rs 280

Now if the market closes at 16000
Then the values should be the following

16500 (PE) - Premium at close - Rs 500 (a loss to me )
16450 (PE) - Premium at close - Rs 450 (gain for me)

NET LOSS : Rs 50
Net Premium Received - Rs 30
FINAL LOSS - Rs 20

But when I see in the NSE Option chain, the Premium values may not be like the above. It may be much more of less, which may give me a greater loss . Is this error specific to NSE’s Option chain data or in actual practice also is this aberration is there ?

2

And I understand there maybe mismatches because price discovery may not be efficient, but can this remain so on expiry too ?
Does it not have to correct on expiry ?

3

Deep ITM (In The Money) Options are illiquid and aren’t traded frequently, the price you see on the option chain will be the LTP (Last Traded Price) and might be higher or lower than intrinsic value due to this, compared to the closing price of the index.

Irrespective of what the LTP is, on the day of expiry, ITM options will be settled at the intrinsic value by the exchange, not at the LTP.

Taking your above example; if the Nifty closes at 16000 both 16500 PE and 16450 PE will expire ITM and will be settled at the intrinsic value, ie. 16500 PE at Rs. 500 and 16450 PE at Rs. 450.

2 Likes
4

@ShubhS9 I want to confirm that all OTM index options will be settled at 0, regardless of whatever the LTP is at 3:29:59 pm on expiry. Is there a nifty and banknifty index option contract specification that you can point me to? My doubt stems from the following situation: If nifty spot if trading at 16500 at close to closing of trading session on an expiry day and there is very low number of sell orders on 17200 CE strike. Say 25000 qty sell orders pending at 0.1 and suddenly someone places a large buy order of 200,000 qty which causes a spike in the price of the option to rs 5. If this trade took place at 3:29:59 and the trading session closes soon after, will the option still be settled at 0? Is there any scenario where an option that is OTM can expire with a positive value?

5

I was talking about those that expire deep in the money (ITM)

6

If the option is OTM it’ll expire worthless, irrespective of at what price it traded last.

1 Like
7

Thank you for your reply
But I have an additional query…

Say I have sold 16500 PE for Rs 200 and the Nifty expire at 16000. Then the Premium should be Rs 500 (the intrinsic value) and my loss should be Rs 300. But if till 3.30 pm there are no buyers at the intrinsic value and the closest buyer (bid offer) is say at Rs 540, then I will make an additional loss of Rs 40. As its In The Money (ITM), I have to square it off before 3.30 pm and then I will be forced to buy at Rs 540 instead of Rs 500, which will be a loss of Rs 340 for me instead 300. If I do not square it off I will be penalized by Zerodha… so whats the way out ?

8

If you want to squared-off the position before 3:30, then you will have to do so at whatever price the buyer is quoting if the option is illiquid.

Also, you can leave your position open to expire. There is no penalty for letting your position expire. It’ll be settled by the exchange at intrinsic value.

9

I was under the impression that all ITM positions have to be squared off by the person. If the brokerage does it , then there will be a penalty !

10

Such a rule of penalising ITM options with huge stt was until 2018/19

As of now, there’s no need to fear if its itm and not squared off…

However be careful when you deal with stock options as it will result in compulsory physical settlement.

@ShubhS9 Sorry if I hijacked the thread.

11

great to hear that

so if i have done a following ITM credit spread

Sold - 16600 PE : Rs 360 Premium Received
Bought - 16550 PE : Rs 330 Premium given

Net credit received : Rs 30 (360-320)

In that case doesnt matter how much the market falls, I shouldnt be having a loss of more than Rs 20.
Rs 30 (Premium credit) - Rs 50 loss (difference between the intrinsic values) = - Rs 20 (loss)

Doesnt matter how bad the price discovery, with the premium difference between the two becoming more than 50… but on expiry the difference will be Rs 50 and the total loss wont be more than Rs 20. Is my understanding right ?