Module 4   Futures TradingChapter 13

Quick Note on Physical Settlement

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13.1 – 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.

13.2 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 and you will receive the delivery of shares to your Demat account.

13.3 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.

13.4 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. 

13.5 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.

13.6 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.

76 comments

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  1. Ravindran S says:

    Your detailed guidelines (Zerodha Varasity) with illustrations on Futures is one of the best presentation that I have seen. It has enlightened me on Futures. I shall thank you to clarify the following doubt:
    From NSEindia website I find the following data against ICICI Bank Futures:
    Date Stock Expiry Volume Open Int Change % Change Historical data
    (contracts) contracts in OI in OI Volume Open Interest Change in OI
    ———– ———— ———— ———— ———- ———— ———– ———— —————– —————-
    (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
    19.06.20 ICICI Bank 25.06.20 55,721 66044 -14243 -17.74 7,66,16,375 9,08,10,500 -1,95,84,124
    Doubts: 1. What is the difference between Col 4 and 8 and between Col 5 and 9
    2. How do you arrive each day closing Open interest figures (Col 9) from OI contract traded (Col 5)

    S. Ravindran
    21.06.20

    • Karthik Rangappa says:

      Thanks Ravindran,

      1) Volume is the total volume traded for the day. % CHange is the change in OI wrt to y’day’s value. I’m not sure about 5 and 9, because I’m unable to read it properly. Can you state that explicitly?

      2) This is an exchange process, they compute and publish the data.

  2. Krishant Sethia says:

    Is physical settlement required only when someone keeps the futures positions open until expiry or it is required even if one closes his positions 2-3 days before the expiry?

  3. Krishant says:

    This course on futures (all the other courses for the matter) are one of the most comprehensive free courses available. The content is just awesome and one can clear doubts easily ,provided the comment section.
    Thank you so much Karthik Sir (and the varsity team) for the efforts to produce such content.

  4. Vaishakh says:

    Hii Karthik sir,
    I have a slight doubt, Since these days its ‘Unlock 1.0’ and the stock market is bullish and people have positive sentiments towards market.
    1) What will be the scenario when the companies release their 1st quarter result in the month of july/august.
    2) If the bulls hit a reality wall of Earnings, (which they will probably face once Q1 earnings are out) how strong that event will be ? I meant, will we be able to see stock downtrend or overall market downtrend ?

    • Karthik Rangappa says:

      1) From whatever reports that are available on the public domain, it appears that most of these companies are expected to report bad quarter
      2) The market has factored in not just this quarter but couple of more quarters Vaishakh.

  5. Arnav says:

    Hi Sir,

    What if someone who has held the long (for example long futures of RIL) position till last day and is unable to square off his position due to liquidity?

    Will they also be settled through physical delivery.

    And what if do not have sufficient funds to take the physical delivery in case of long futures.

    • Karthik Rangappa says:

      Yes, Arnav, it will be settled physically. The position will be closed in case you dont have the necessary margins leading up to expiry.

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