Module 5 Options Theory for Professional Trading

Chapter 24

Quick note on Physical Settlement


24.1 – Overview

Until recent times, trading in equity futures and options was cash settled in India. What this means is that upon expiry of the contract, buyers or sellers had to settle their position in cash without having to take delivery of the underlying security. On April 11, 2018, SEBI released a circular making physical delivery of stocks for all stock F&O contracts mandatory in a phased manner. The aim was to curb excessive speculation which would result in too much volatility in individual stocks.

24.2 What is Physical Settlement? 

It means all stock F&O contracts at expiry, are required to be given/taken delivery of the underlying security. From October 2019’s expiry, all stock F&O contracts are compulsorily settled physically. 

Let’s understand this with an example, before the introduction of physical settlement, if you bought only a lot of SBI futures expiring this month, on expiry, the contract will be cash-settled based on the settlement price and you will receive the credit or debit in your trading account. We’ve explained how marked to market settlement works in this chapter. But with the physical settlement, if you don’t close or rollover your position till expiry, you are required to pay the total contract value and you will receive the delivery of shares to your Demat account.

24.3 Why is Physical Settlement enforced?

When the contract is cash-settled, traders only are required to maintain the margin(SPAN +Exposure) for the contract and can lead to short-sellers building up excessive short positions closer to expiry artificially bringing down the price. With the physical settlement, these traders will have to buy the stock from the equity market or borrow on the SLB markets to be able to deliver the stocks to the counterparty. This brings in balance to the price not allowing for price manipulation.

24.4 How are positions settled?

On expiry, various F&O contracts are settled in the following manner

  1. Take Delivery(stocks are delivered to your Demat account)- Long Futures, long ITM Call and short ITM Put
  2. Give Delivery(you are required to deliver the stocks to the exchange)- Short Futures, short ITM Call and long ITM Put. 

Only ITM options will be physically settled, if the option expires OTM, they expire worthlessly and there won’t be any delivery obligation. 

24.5 Netted off positions(subcategory)

If you have multiple positions of the same underlying for the same expiration date and they form a hedge, depending on the direction of the trade, they will be netted off.

1st Leg 2nd Leg
Long Futures Short ITM Call

Long ITM Put

Short Futures Long ITM Call

Short ITM Put

Long ITM Call Long ITM Put

Short ITM Call

Long ITM Put Long ITM Call

Short ITM Put

Short ITM Call Long ITM Call

Short ITM Put

Short ITM Put Short ITM Call

Long ITM Put

For example, if you have an SBI June long futures contract and long ITM Put of strike 200(SBI spot price at Rs 180), the long futures position will lead to a take delivery obligation and the long put option to a given delivery obligation. This will be netted off for your account and there won’t be any physical delivery obligation.

24.6 Margins

When you are trading in the F&O segment, for futures and short options, you will require to maintain only the margin amount in your account, for long options, just the premium required to buy. However, this changes with the physical settlement mechanism, where you are required to bring in 100% of the contract value to take delivery of the contract or bring in stocks to give delivery(depending on the direction of your trade). Brokers introduce additional margins when such positions get closer to expiry. 

You can read on Zerodha’s physical settlement policy here.


  1. Yuvraj says:

    Hello sir,

    If I don’t hold any shares in my account and can I sell put options in order to buy at lower price?


  2. Nitish Kumar says:

    Hi sir.
    in order to not get in a position to become liable for physical delivery one should square off the position latest by the 1st half of the expiry ? i trade mostly through covered call in nifty companies and premium decay mostly happen on the last two days very fastly.
    Your insight on this point sir.

    • Karthik Rangappa says:

      You can keep the position open till the first Monday of the expiry week, Nithish. From the first Monday, the margins go up because of the physical delivery.

  3. Srikanth K V says:

    Hi Karthik,

    I am a newbie to options,
    1)I would like to know what is the starting day of the new option(call/put) .
    Example : I could see INFYCEXXXX EXPIRING ON 30TH AUG (on which day it was it added to option chain).

    2) physical settelement is enforced on when trader failed to squareoff his position before the expiry of the contract(thrusday/last thursday), please clarify the same.

    • Karthik Rangappa says:

      The Aug contract will be introduced at the beginning of May. In June, May contract would cease to exist and Sept would be introduced.

  4. Dalip Vachani says:

    Hi Sir,
    I am new to options trade. Suppose I sell call option of SBI with a strike price of Rs. 200/- and I don’t square off the position.If the option is in the money on expiry date July 30, 2020 and SBI stock closes at Rs. 210/- will I have to give delivery of 3000 shares of SBI or intrinsic value of Rs. 10(210-200)*3000= 30000/- will be debited to my account.


    1.If I keep sell position for CE/PE For Index till expiry, so there is also margin will be increase from last week of monday Or this is applicable only for Stocks
    2..If I keep sell position for CE/PE For Stock till expiry, so there is how much margin will be increase from last week of monday i.e.MON/TUE/WED

  6. Sriram Ramanathan says:

    Question 1
    I have placed a Long call on Nifty Jul 11000 CE by paying a premium of 110 per lot (75). 8250 has been deducted as premium.
    On 30th July, Nifty closes at 11300 and I let my option to expire ITM. With cash settlement earlier, without me doing anything, I think I would be getting 22,500 (300*75) in my account. With this new mandate of physical settlement, do I have to still buy the 75 shares @ 11000 per share, which means I have to additionally pay 8,16,750 (11000*75-8250)? Apologies if I have got this completely wrong.

    So, can this also raise to a defaulting scenario?


  7. Sriram Ramanathan says:

    Thank you Karthik. Good. So, there is no change if i want to trade only on the indices. Everything still remains the same.
    But the point about paying 8,00,000+ amount is still then good if instead of NIFTY, if it was some stock. Is that right then?


  8. Sriram Ramanathan says:

    Okay Karthik, I will share the context better. Disclaimer – I havent started doing options trading, but planning on trying after going through your excellent modules. So, some of my terms usage might not be 100% correct, as I am still learning

    Question 1

    I have placed a Long call on Divis Jul 2300 CE by paying a premium of 42.60 per lot (400). 17040 has been deducted as premium.
    On 30th July, Divis closes at 2400 and I let my option to expire ITM. With cash settlement earlier, without me doing anything, I think I would be getting 40,000 (100*400) in my account. With this new mandate of physical settlement, do I have to still buy the 400 shares @ 2300 per share, which means I have to additionally pay 9,02,960 (2300*400-17040) and get it delivered?
    Apologies if I have got this completely wrong.

    Can this also then raise to a defaulting scenario?


    • Karthik Rangappa says:

      Ah yes, the closer you move to expiry, the margin requirement or stock requirement goes up, which means to say that you need to have the necessary funds/stocks to hold to expiry. Else if you don’t want to get into that, then it is better to close before expiry.

  9. Sriram Ramanathan says:

    Question 2

    Are you seeing less volumes of Options trades after this physical settlement mandate. I would assume so, with so many changes, delivery charges, STT etc., Is it the case in reality? If not, i would like to know the reason for similar volumes being traded. What am i missing to understand.


    • Karthik Rangappa says:

      Not really, the bulk of the action is anyone on Nifty and Bank Nifty. So there is no reduction in volume as such. But yes you are right, a single stock option is not as vibrant as the index option.

  10. Dr Rahul M says:

    Suppose i have sold a put option for icicibank aug 300PE at R6. Should i do something manually at the end of expiry? If icici stock price goes below 300,is it enough that i maintain money (415000) in my account and the shares delivery will be done? Experts please answer. Am new to this

    • Karthik Rangappa says:

      Yes, you just need to ensure that you have sufficient margin in the system to take delivery of the shares.

  11. BSRANA says:

    I am new in the options world. Have zerodha account. I am not clear as to what is reqired to be done with regard to option trading in stocks
    Suppose i have a l Lot of HDFC @1798 in my portfoilo. I sell a call of 1850 CE @46.
    my question(1) can my holdings be treated as margin. if yes ,then how? How will physical settlement take place if
    (2) stock price remains at or falls below 1850. i wil sit on profit. (3) between 1850 to 1896 and my position in partial profit or zero profit at break even point.
    (3) Stock price goes above 1896 and closes say at 1910 making Loss.
    How does the physical settlement take place . Will i have to arrange for additional funds. Buyng or selling security physically will entail STTetc making these strategies loss making ??. Do not mind if i have raised some irrelevent querries due to knowledge gaps.

    • Karthik Rangappa says:

      1) Yes, in case of holdings, the stocks will suffice. But this is not a replacement for margins.
      2) Yes, below 1850, you get to retain the entire premium received
      3) That’s right
      4) You will have to give stock, which you already have in your DEMAT. Yes, STT will be applicable to both buy and sell @ 0.1%.

  12. Jyoti says:

    Hi sir,
    In physical settlement where there is obligation to give the delivery of the stock if i do not hold those stocks in my demat account how can i give the delivery ? because for CNC trades i cannot short shares right ? i am little confused here please clarify.
    Thank you

  13. Debu says:

    Hello sir,
    I have two queries:
    1) If I short HDFC BANK 900 PE and on expiry the spot price become 880/- then it is ITM. In this case the margin which I have to hold is 900*(550 lot size)= 495000/- ?
    2) If I long HDFC BANK 900 PE and on expiry spot price is 880/- ITM then in this case do I have to hold the same margin as earlier or 880*(550) = 48400/- and the system then credits the 11000/- profit.

  14. Bhupesh Gupta says:

    Hello sir,
    I have 4 queries, Both are related to the expiry of the options and there physical settlements.

    Lets take an Example:- If we have X stock.Current Price 100 rs on 21-7-2020

    Situation 1:- I Buy a Call @ 100 for this Stock, and on expiry it goes to 110 then how I will get delivery
    Question a.) How will i get delivery, is it at 100 Rs. or 110 Rs.?
    Question b.) will i get this Stock in my Demat account and then i need to sell it in the Market whenever i want or, it will be automatically Settlle n give me profit?

    Situation 2 :- I Sell a Call @ 100, and Again Stock goes to 110 on expiry.
    Question c.) how Physically i can give delivery to Buyer of the call. If Manual then how? if Automatic then how?
    Question d.) If I already have this Shares in my Demat account , then how can i tell Zerodha to give my Shares of Demat (Old holding of the Same X Stock)?

    Situation 3:- If i Sell a Put @ 100 and Stock goes to 90 rs. on expiry
    Question e.) At what price i will get stock @ 100 or 90?
    Question f.) Will i get stock Automatically and , Can i Sell it whenever i want?

    Situation 4:- If i Buy a Put @ 100 and Stock goes to 90 rs. on expiry
    Question g.) how will i sell @ 100 to seller or its automatic.
    Question h.) if i sell it manually then how to do it so to book profit or anything else if i am wrong?

    Thanks a lot in advance…
    User of Zerodha

    • 1. a. If you maintain the margins required, you will receive the shares in your demat account for Rs 100 a share(strike price). Your buy average will be Rs 100 + Premium paid to buy the call option.
      b. Yes, it will be delivered to your demat account. You are free to hold it or sell it whenever you like.

      2. c & d. If you have the stock in your demat account, the shares will be automatically debited and settled to the exchange. If you don’t hold these shares, it will go to auction, where us(Zerodha) will buy the share for you and deliver to the exchange(auction penalty will apply).

      3. e. You will get the stock at 100(Strike price). Your buy average will be 100 – premium you sold the contract at.
      f. Yes, same as point 1. b.

      4 g & h. Same process as point 2 c & d.

  15. SUMIT says:

    My query is as follows
    I am holding 550 (lot equivalent) shares of HDFC BANK. I decide to sell a CALL of Rs. 1000/-
    1. TWO DAYS BEFORE THE EXPIRY- CMP is 1050/- What will be the approximate margin required?

    2. ON THE DAY OF EXPIRY- CMP is Rs.1100/- Do i need to provide (1100 * 550lots size = Rs.605,000) as margin ? If yes, How do i reduce the Margin knowing that I am already holding the shares in my Demat account and intend to give the delivery of the same?

    3. For the above what is the time frame i have to PROVIDE the margin? End of the day? Start of the day?

    4.Under what circumstances does Zerodha square off positions for insufficient margin? Any penalty? etc

  16. Varun Agrawal says:

    Hello Karthik,

    I just need your small advice based on one of my observations. Hope you don’t mind.

    I noticed if I had sold a deep OTM 2300 strike for Reliance on Friday afternoon for a premium of 15.55, because of theta decay, it would become 5.1 on Monday morning according to the BS calculator. If nothing changes and I sell at exactly 9:15 AM, I will get 3x returns. I noticed the same is true for many other stocks too like MSFL which has been in sideways channel, the whole month.

    The only thing against me is pre-market changes and volatility. According to the same calculator, it would require 3.2% of pre-market changes or a 25% increase in IV for my position to go in the red. Let’s suppose 3.2% is unlikely.

    My question is what are you general observation towards IV in the expiry week for options? Does it usually shoots up or down?

    Many Thanks.

    • Karthik Rangappa says:

      In an ideal world yes, all else equal theta kicks in and you get to make the decay. However, in reality this hardly happens and there in influences working on the stock prices all of which manifest in different forms – Delta, vega, gamma etc. They all have their own impact on premium and therefore the theta decay concept is hard to monetize.

  17. Nikhil says:

    Hi Karthik ,
    Would be great if you could help understand concept of physical settlement & Covered Call in the following scenarios ( let’s assume i had bought Reliance Call option ATM @ 1800 ) :- 1. Taking Stock delivery through options contract by letting a Call option expire in the money – When I browsed online I couldnt find any site which actually advised on taking stock delivery due to high STT. So is there a scenario where you are deep in the money and when it would make sense to take delivery if you have a long term view on the stock and would like to own the stock? Like Reliance in this example. Or its generally better to square off the option & may be buy in cash market for long term.
    2. Covered call – With the deep in the money call that I was holding would it have made sense to Sell a higher Call option (2100) to make more money as I didnt think the price would go below my Call option strike price and let both the options expire. Or it is generally better to square of the call option and take the profit?Assuming a) Reliance at expiry above 2100 – both options would have expired ITM & cancelled against each other to give profit without needing physical settlement ( also avoiding higher margin for short CE)? b) if price were to settle between 1800 to 2100 on expiry day – I could square of my 1800 long if I wanted to avoid settlement & let the 2100 sell call expire to get the premium?
    3. Also what is your view on this dynamic covered option strategy in scenarios where you had bought a CE/PE which is in the money (instead of just squaring the long option) and you are of strong view based on technical/fundamental analysis that the stock price is going to remain in a range and not going to cross your ITM CE/PE till expiry (or even if it does you could square of the long position & hold the short position till expiry)? Like in this example.

    Thanks for your response.

    • Karthik Rangappa says:

      1) You can take physical delivery when you have a significant price advantage. In this, you’d have paid quite a bit for 1800CE since its deep ITM, so unless RIL goes way higher wherein the premium you’ve paid is compensated plus you have an advantage over the share price, it does not make sense to take physical delivery. I’d avoid buying shares via this approach (unless the option I buy turns deep ITM). In other words, after I buy the option the stock has to rally 10 or 15% more.
      2) This is not a covered call. In a covered call, you have RIL in DEMAT, and you sell a CE against this. What you have described is a bull call spread –
      3) I prefer spreads over a regular naked position. Also, if the view is directionally strong, you are better off with futures, right?

  18. Vinodkumar Kasandaria says:

    Can I request you sir about call and put option ?
    As still I have to be member of Zerodha institution .

  19. kedar (KD) says:

    Hi Karthik,
    Thank You so much for your invaluable suggestion and advice to we new bees in trade world.
    My question is I have taken a 11000 CE (102.2 Premium), for 30th July expiry. The option is already in ITM now, do i need to settle physically to bag the profit or it will happen automatically after the trading hours on 30th July?

    Also would request you to share a little note on physical settlement piece for both indices & stocks, since so many queries are gearing up. Highlighting the case, on how can some one earn by just selling the option before the expiry, It would be of big help for we robin hood investors.

    Thanks again for your kind help and advice.


  20. Trilok says:

    I have sold a call and now 2 days before the expiry date i got a message that my margin requirement have reached 133% of the account balance. My trade is currently in profit. I have below questions:

    a) At what point zerodha will square off this position? What would the margin percentange breach for zerodha to square off this trade?

    b) Currently my margins available shows -2.22L. Am i paying any interest/charges to zerodha to get this margin as its negative now.

    • I believe you have a stock options position. Answering below-
      a. Zerodha can square-off the position anytime on Wednesdsay and Thursday of the expiry week once you have breached 100%.
      b. Yes, interest at 0.05% per day will be charged for the negative balance in the account.

  21. Selva says:

    It read this very long ago that a zerodha trader earned lakhs by trading minutes before expiry but ended up defaulting as he has to pay much more than that as STT, atlast zerodha payed the penalty to the exchange. Does that mean we should never forget to close the contract before expiry. Kinda scary 😨

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