I read the new NSE circular regarding the ‘Do not exercise’ facility on options derivatives. As a retail client what steps do I take to exercise this facility?
Let’s put down a few pointers before we see the basis on which ITM options will be exericised.
- The Security Transaction Tax(STT) for option trades is 0.05% of the options contract value and is applicable only on the option sell trade.
- The options contract value for the purpose of calculation of STT is [(Strike price+Premium) * Quantity]
- If you allow your option buy positions to exercise on expiry day, then the STT for exercising this option increases to 0.125% of the options contract value. The STT increases 25 times.
- Exercising an option simply means that you keep your option position open at 3.30pm on Expiry day and the exchange will settle it for you if it is In-The-Money.
Let’s take an example where you’ve ended by with an option contract that is just In-The-Money at expiry.
Assume you’ve bought 20 lots of Nifty 9900 Call at Rs.25 each. The quantity of this option contract is 1500(20 lots * 75 lot size) and the Premium you pay to buy these 20 lots is Rs.37,500.(1500 * 25). Now if this option contract ends up just in the money at expiry because Nifty spot closes at 9905, your option still has an intrinsic value of Rs.5 per lot(as the spot closed 5 bucks above your call option strike price). Let’s calculate how this pans out if the option is exercised and if it isn’t exercised.
Case 1: The option contract is exercised.
In this case, the option contract will be settled by the exchange. The option contract value is [(9900+5) * 1500] which is Rs.1,48,57,500 and the STT on this is 0.125% of the contract value which is Rs.18,572. But the intrinsic value of the option you will get back is only 1500*5 = Rs.7500. On what appears to be a profitable trade, you actually end up paying more STT that the option premium you receive back. Here, you end up in a loss of Rs.11,072. This is the famous STT trap.
Case 2: The option contract is not exercised and is lapsed.
This eliminates the STT trap, let’s see how. Since your option contract is just In-The-Money and the STT value at option expiry is greater than the option premium value you receive back, the onus is on the broker to ensure that this contract is lapsed for the benefit of the client and is not exercised. To lapse the option, the Broker will have to update this option position in the ITM options contracts file received from the exchange at expiry with a ‘Do not exercise’ flag within the cut off time. The client holding the position does not have to perform any steps for this, the broker will do it on his behalf.
Here, both the option buyer and the option writer/seller benefit. The option buyer avoids paying excess STT and he only loses his option premium he paid initially. The option writer ends up keeping the premium he received while writing the option.
3 Likes
Nobody likes to be trapped! This is a good move for the participation and health of options traders in India. Cheers 
Hi @BharatW Isn’t it should be (9900+5)*1500 instead of (9900+25)*1500…??
If you can please confirm…!!