TABLE OF CONTENTS

Note

As a policy Tradeplus will not allow F&O positions to be carried forward till the end of the expiry for physical settlement to take place.  All open positions will be auto squared off by RMS team 30 minutes prior to the market closing on expiry day. Read more on our policy here


What is physical settlement in Equity Derivative means?

SEBI wide its circular dated April 11, 2018 introduced physical settlement of stocks derivatives traded in F&O segment since July 2018 in a phased manner and it is made compulsory for ALL stock derivatives that come up for settlement on expiry day from October 2019.


Physical settlement of security means, on the expiry day, instead of cash settlement  actual physical delivery of stocks should be made.  For example, if you had sold TCS futures and carry the position till expiry day, then you will have to give delivery of physical stock of TCS.  Similarly, if you had bought a stock in futures and carry the position till expiry, then you will have to compulsorily take physical delivery of that stock by paying the full value.


Since most people trading F&O usually have just a small portion of the overall contract value blocked as margins (Futures and Short Options) or premium (Long calls & puts), the actual obligation of taking or giving delivery can be exponentially higher. This increases the risk for brokerage firms significantly and results in higher margin requirements. 


Which are the positions will be marked for physical settlement ?

Futures : All stock futures positions that are open after closing of trading on expiry day will have to be physically settled.

Options : All in-the-money (ITM) contracts and close to money (CTM) contracts that are open after closing of trading on expiry day will have to be physically settled.

Exchanges have defined Close to money (CTM) contracts which are a subset of ‘in the money (ITM)’ or contracts that expire with some intrinsic value.

For Call Options – 3 ITM options strikes immediately below the final settlement price shall be considered as ‘CTM’. For example, if Wipro contract settles at 243 on expiry day, call options with strike 230, 235, and 240 will be marked as CTM contracts

For Put Options – 3 ITM options strikes immediately above the final settlement price shall be considered as ‘CTM’. For example, if Wipro contract settles at 243 on expiry day, put options with strike 245, 250, and 255 will be marked as CTM contracts

How settlement obligations are computed for physical delivery?

Futures

All long futures position that are open will result into a buy positions.  For example, if you had bought a stock futures and carry it till expiry then you have to take delivery of the stock by paying the full value.

All short futures position that are open will result into a sell. For example, if you had sold a stock futures and carry the position till expiry then you have to give delivery the stock against your sale.

Options

In-the-money call options

All long call exercised shall result into a buy. For example, if you had bought a call option and carry the position till expiry then you have to take delivery of the stock by paying the full value.

All short call assigned shall result into a sell.  For example, if you had sold a call option and carry the position till expiry then you have to give delivery of the stock against your sale.

In-the-money put options

All long put exercised shall result into a sell. For example, if you had bought a put option and carry the position till expiry, then you have to give delivery of the stock.

All short put assigned shall result into a buy. For example, if you had sold a put option and carry the position till expiry, then you have to take delivery of the stock.

The quantity to be delivered/ received shall be the market lot * number of contracts that come up for physical settlement.  For example, if the market lot of the stock  futures or options contracts that come up for physical settlement is 1000 and you have 10 contracts left open, then the total quantity that comes up for physical settlement will be 10,000 (1000*10). 

How the settlement obligation value be computed for physical delivery?

Futures

Delivery settlement obligations value will be the final settlement price of the respective contracts. The settlement price will be the average price of the stock traded in cash market during the last 30 minutes on the expiry day.  

Options

Delivery settlement obligation shall be computed at respective strike prices of the option contracts

What is Pre-expiry settlement margins for Futures and Options ?

Futures and Short Option (Calls & Puts) positions

There will not be any change in Margins. Exchange defined SPAN + EXPOSURE margins will be applicable for Futures (long or short) and Short options (call and puts)


Long/Buy option (Calls & Puts) positions

The Exchange charges physical delivery margins as a percentage of applicable margins(VaR + ELM +Adhoc) of the underlying stock which is levied from expiry minus 4 days for long ITM options in the following manner. The exchange will also levy margin penalty for shortages in margin. Hence where ever there is margin shortfall we would square off your position.


DayMargins applicable
E-4 Day (Friday EOD)10% of applicable margins
E-3 Day (Monday EOD)25% of applicable margins
E-2 Day (Tuesday EOD)45% of applicable margins
E-1 Day (Wednesday EOD)70% of applicable margins


What is the settlement deadline for the physical settlement of equity derivative contracts?

The physical settlement deadline shall be Expiry+2 days for pay-in/ payout of securities and funds.

Is any margin process changed on physical settlement of securities in Equity Derivatives?

The margin framework as explained above shall continue to be applicable till expiry of derivative contracts.

Post expiry, positions which are converted to physical settlement, margins as applicable in Capital Market segment (i.e VAR, Extreme Loss Margins, Mark to Market margins) shall be applicable and levied as delivery margins. Delivery margins shall be part of the initial margins of the Client.

Mark to Market margins - End of day mark to market margins shall be computed on the expiry and expiry + 1 day as difference between settlement obligation and value of positions at closing price of the security in the Capital Market segment. Mark to market loss in one security shall be netted against profit of other security for the same client. Net loss at client level shall be grossed to arrive mark to market margins.

Delivery margins blocked shall be released on completion of settlement.

In case of in-the-money options contract assignment margins shall not be computed on positions which shall be identified for physical settlement.

How the pay-in shortage of securities handled on Physical settlement on Equity Derivative contracts?

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 auction shall be conducted on Expiry+3 days and settled on Expiry+4 days. The auction amount shall be charged to the seller who failed to deliver the stock.  If the auction is unsuccessful and still there is short delivery in auction then shortage shall be closed out.

Penalty of 0.05% per day will be charged for the client who fail to deliver the stock. 

How can I avoid physical settlement when an option position is held after closure of expiry day market?

All in-the-money contracts are mandatorily subject to physical settlement.  

However in case of close to money (CTM) contracts, traders have a facility called do-not-exercise. Close to money contracts are the ones which settles with some intrinsic value. For example, if you have bought a call option with strike price of 345 and the stock closes at 348 on expiry day, then this contract has intrinsic value of Rs.3.  This contract is said to be CTM contract.  And everyone who holds CTM contracts have the facility to opt for do-not-exercise. Upon a trader opting for do-not-exercise, the contract expires unexercised.

In case of the seller of the stock option contract, if the contracts are assigned against the open position for physical delivery by exchange, he has to mandatorily give/take delivery of the stock.

Further reading - NSE FAQ documents – 1 & 2.
With all this in consideration, it is advisable for a client to square off all positions on your own before expiry.