Policy on settlement of compulsory delivery derivative contracts — Update Oct 2019
What does compulsory physical delivery mean?
As stated in this SEBI circular, starting from July 2018 expiry, F&O positions are being settled moved from cash settlement mode to compulsory physical delivery settlement in a phased manner. Starting from October 2019 expiry, all stock F&O contracts will be compulsorily physically settled. If you hold a position in any Stock F&O contract, at expiry, you will be required to give/take delivery of stocks.
The deliverable quantity is computed as under
- Unexpired Futures
- Long futures shall result in a buy (security receivable) position
- Short futures shall result in a sell (security deliverable) position
- In-the-money call options
- Long call exercised shall result in a buy (security receivable) position
- Short call assigned shall result in a sell (security deliverable) position
- In-the-money put options
- Long put exercised shall result in a sell (security deliverable) position
- Short put assigned shall result in a buy (security receivable) position
- Unexpired Futures
The quantity to be delivered/received shall be equivalent to the market lot * the number of contracts that result in a delivery settlement.
This is a significant change to how these contracts were settled earlier – by cash. Also, 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 us as a brokerage firm significantly. Below is our new policy on physically settled derivative contracts which is part of our broader RMS (Risk Management) policy.
Futures and Short Option (Calls & Puts) positions
- The margin requirement for all Stock F&O contracts will be increased on the expiry day to 40% of the contract value or SPAN + Exposure margins prescribed by the exchange(whichever is higher).
- These margins will be debited on your trading ledger. The increase in exposure margin is to cover for the additional obligation that will arise if these contracts are held until expiry and result in physical settlement.
- For example, if the margin required for Allahabad Bank futures is normally 25% as SPAN+Exposure of the contract value, it will be 40% of the contract value on Thursday(expiry day).
- You can check for the increased margin requirement on our SPAN margin calculator.
Long/Buy option (Calls & Puts) positions
- There will be a physical delivery margin charged for all In-the-money(ITM) long options. This will be 50% of the contract value.
- 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
- For long ITM Put options, you will be allowed to carry your position until expiry if you maintain sufficient margins as explained above. An exercised Put option would result in you having to deliver shares to the Exchange. As such,
- If you hold the shares in your demat account, such shares will be debited towards meeting the Exchange settlement obligation.
- If you don’t hold the shares in your demat account, you wouldn’t be able to deliver the shares towards the physical delivery obligation, resulting in short delivery. Appropriate auction penalties from the Exchange shall be charged on your account for such short deliveries. Read more on the consequences of short delivery here.
OTM (Out of the money) options are those strikes that are above the final settlement price for calls and below the final settlement price for puts. There won’t be any delivery obligation if your call or put option expires out of the money(OTM).
Policy regarding Close to Money contracts (CTM) Exchanges have provided an option to not exercise long CTM contracts. We will be using this option on expiry day in case the cash balance and the intrinsic value of the option contract is less than twice the SPAN+Exposure margin (Exchange mandated) required to take a position in the futures contract of the same stock for the current expiry. For example: If you are long 1 lot of WIPRO Oct 19 240 CE and let it expire and WIPRO(Stock) settles at Rs. 243, this contract will be a CTM contract. The intrinsic value of this contract will be 3 [243-240] x 3200(lot size) = Rs 9600. Post-market closing we will check if the client’s free balance (Cash balance + Rs 9,600) > Rs 3,11,040 ( 40% of the contract value or twice the SPAN +Exposure margin for WIPRO Oct future contract). If client balance is lesser than Rs 3,11,040, this position will be marked as “Do not exercise” and the option contract will expire worthless. If the balance is more than the required margin, we will let the option be exercised, resulting in physical delivery. All costs arising out of such delivery obligations will be applied to the client’s account.
Update: NSE has released this circular discontinuing the DNE (Do not exercise) facility for CTM contracts from October 14, 2021.
In the money contracts (ITM)
All ITM contracts which aren’t CTM will be mandatorily exercised by the exchange. This means that anyone holding an ITM option contract will receive/give delivery of stocks depending on whether one is holding call/put options. All the costs arising out of this delivery obligation will be applied to the client’s account.
Out of the money contracts (OTM)
All OTM options will expire worthless. There will be no delivery obligations arising out of this.
Spread and covered contracts
Spread contracts that result in both – take and give delivery obligation will be netted off for the client. For example, you have a bull call spread of Reliance of the same expiry, a lot of long call options of strike 1300 and a lot of short call options of strike 1320 and the spot expires at 1330, this will result in a net-off and there won’t be any delivery obligation. Here a few cases highlighted below which will result in a net-off of physical delivery obligation for contracts of the same expiry.
|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
Margins will be charged separately on all legs of spread contracts(credit and debit spreads, iron condors, etc) and for covered call positions given the risk on the broker(Zerodha) that you can exit one of the legs of the spread before expiry leading to a physical delivery obligation. You will still continue to receive SPAN margin benefit for the contracts(if any).
Random Assignment of short CTM Position
In case you’ve written an option that expires ‘in the money’ and have left such position to expire, the assignment of such CTM option is done randomly by the Exchange. In the event that your option contract does not get assigned, you are entitled to retain the premium. However, if an option gets assigned to you, you will have to give/receive delivery of stocks depending on whether you have written a call/put option.
Buy/Sell price of the physically settled stocks
The expiry day will be the buy/sell date of the shares that have undergone physical delivery. The buy/sell price for the various cases is as below-
- Long/short futures- The settlement price on the expiry date will be the buy/sell (average) price of the stocks.
- Call/Put options – ITM options get exercised but expire at 0 value. The strike price of the contract will be the buy/sell (average) price of the stocks.
Additional costs of physical delivery
- All positions that result in you receiving delivery of shares will require you to have funds equivalent:
- For Futures: Settlement Price * Lot Size * Number of lots
- For Options: Strike Price * Lot Size * Number of lots
- All positions that result in you having to give delivery of shares will require you to have shares in your demat account equal to the deliverable quantity. In the event that you do not have the required quantity of shares, this settlement would result in a short delivery. Appropriate penalties shall be charged on such short deliveries. This can be as much as 20% or more. Read more on the consequences of short delivery here.
- Margin penalties will be charged as prescribed by the exchange for all F&O positions(including long options contracts).
- Since there is a substantial increase in effort and risk to settle these F&O positions resulting in physical delivery, a brokerage of 0.25% of the physically settled value will be charged. For all netted-off positions(spread contracts, iron condor, etc), the brokerage will be charged at 0.1% of the physically settled value.
- As clarified by the exchange based on the direction of the Hon’ble Bombay High Court, all physically settled contracts(both Futures and Option) will carry an STT levy of 0.1%(applicable for equity delivery trades) of the contract value for both the buyer and the seller of the contract.
- Interest will be charged at 0.05% per day if your account results in a debit balance when the additional margins are applicable(two days before the expiry day)
- You are required to bring in funds if your account results in a debit balance after physical delivery failing which the delivered shares will be liquidated to make good of the debit balance. Interest will be charged at 0.05% per day on the debit balance in the account.
- All give delivery positions will require you to have the shares equal to the lot size in your demat account during the expiry week failing which it will end up in short delivery. Read the consequences of short delivery here.
- Stocks received by means of physical settlement can only be sold after receiving delivery of stock in the demat account (2 working days after expiry). In case of a short delivery, the credit of shares will take up to 4 working days after expiry.
- If you have 2 open positions on expiry that result in a net-off(Long futures and short call options, short put, and short future, etc) you are not required to give or take delivery for the position. However, there will be STT charged on the long position(s) as this is treated as notional delivery.
- Fresh long option positions will not be allowed on Wednesday and Thursday of the expiry week. Fresh positions will be allowed for futures and options writing contracts throughout the month. The allowed product types are NRML and MIS.
- You need to have a Zerodha demat account linked to your trading to trade in compulsory delivery contracts. This is to ensure that the stocks are credited in your demat account in the event of physical delivery.
- The increased margin requirement mentioned above is applicable on Wednesday(Expiry -1 day) and Thursday(Expiry day). If the contract expiry is changed to a different day, the same will be applicable from one day before the expiry day.
- In the event that you do not fulfill these margin obligations on time, your positions are liable to be squared off. Any loss arising out of such square off would be the sole responsibility of the client. For any reason which our RMS team is not able to square-off a margin shortfall position(s) and leads to compulsory physical delivery, the costs and risks of physical delivery will be applicable to the client.
- Contracts settled through physical settlement are illiquid closer to expiry. Any losses arising out of liquidation of position(s) with margin shortfall by our RMS team have to be borne by the client. It is advisable for a client to square-off such positions on their own or add funds to carry the position(s) to expiry.
- This policy may be changed at the discretion of the RMS team.
You can read these 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.