What does compulsory physical delivery mean?
As stated in this SEBI circular, starting 26th July 2018, F&O positions in the 46 stocks mentioned in this NSE circular will be settled via compulsory physical delivery (More stocks have been included to the list later on. The current list of stocks can be found here). If you hold a position in any of these contracts 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
The quantity to be delivered/received shall be equivalent to the market lot * the number of contracts which 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
- Span + Exposure margin for all contracts which are going to be physically delivered will be increased 3 days prior to expiry or on Monday leading to the Thursday expiry in the following order.
|Day||Percentage of Contract Value|
- 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 till expiry and result in physical settlement.
- If the SPAN +Exposure margin is higher than the above-mentioned margins, the exchange margin will be levied.
- So for example, if the margin required for Allahabad Bank futures is normally 25% as SPAN+Exposure of contract value, it will be 40% of contract value on Monday leading to expiry.
- You can check for all SPAN and Exposure margin on our margin calculator. Alternatively, you can check for these normal %’s on margin PDF file.
- 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.
Long/Buy option (Calls & Puts) positions
Exchanges have defined Close to money (CTM) contracts which are a subset of ‘in the money (ITM)’ or contracts which expire with some intrinsic value.
- For Call Options – 3 ITM options strikes immediately below the final settlement price shall be considered as ‘CTM’
- For Put Options – 3 ITM options strikes immediately above the final settlement price shall be considered as ‘CTM’.
The exchange has mandated that even long call and put options will require margins to be blocked starting from the September expiry. The margins will be applicable 4 days before expiry. This will be charged as a percentage basis on the applicable VaR + ELM of the underlying contract. Additionally, starting from February 2019 expiry, we will be blocking margins as a percentage of the contract value(or SPAN+Exposure, whichever is higher) in the following order-
|Day||Percentage of Contract Value|
For ITM Put options, you need to hold deliverable shares(equal to the lot size of the contract) in your Demat Account on the day of expiry along with the applicable margins mentioned above.
OTM (Out of the money) options are those strikes which are above the final settlement price for calls and below the final settlement price for puts.
Policy regarding Close to Money contracts (CTM)
Exchanges have provided an option to not exercise CTM contracts. We will be using this option on expiry day in case the unencumbered net-worth (explained below) of the client’s account (Cash balance + Value of Stocks in Demat account + Intrinsic value of Option Premium) is less than SPAN+Exposure margin (Exchange mandated) or 50% of contract value whichever is higher required to take a position in the Future contract of the same stock for the next expiry.
For example: If you are long 1 lot of ALBK Feb 40 CE and let it expire and ALBK(Stock) settles at Rs. 42, this contract will be a CTM contract. The intrinsic value of this contract will be 5 [42-40] x 13000 (lot size) = Rs 26000
Post-market closing we will check if Client’s free balance (Cash balance + Value of Stocks in Demat account + Rs 26,000) > Rs 1,42,619 (SPAN +Exposure margin for ALBK Feb future contract) or Rs 4,36,800 (80% of contract value). If client balance is lesser than Rs 4,36,000, this position will be marked as “Do not exercise” and the option contract will expire worthless. If the balance is more than the SPAN+Exposure, we will let the option be exercised, resulting in physical delivery. All costs arising out of such delivery obligation will be applied to the client’s account.
For long put options, if the deliverable shares are not available in the demat account, they will be marked as ‘do not exercise’.
Note – Collateral holdings and mutual funds won’t be considered as part of net-worth of the client’s account.
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.
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.
- Margin penalties will be charged as prescribed by the exchange for all F&O positions(including long option contracts)
- Since there is a substantial increase in effort and risk to settle these F&O positions resulting in physical delivery, a brokerage of 0.5% of the physically settled value will be charged.
- 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% of the contract value for both the buyer and the seller of the contract.
- 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
- 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).
- VaR stands for Value at Risk is the minimum margins charged by the exchange in the cash segment. This is designed to cover the losses of a share based on its historical price trends and volatility. The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR margins.
- Unencumbered net-worth of an account comprises of free cash, value stock holdings (that are not pledged or have any other lien against them). Value of mutual fund holdings or collateral received from pledging of stocks/mutual funds will not be considered when calculating unencumbered net-worth.
- 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.
- Starting from the October Expiry, you will be able to take fresh futures and option short positions in the expiry week till Wednesday(Expiry-1 Day). The allowed product types are NRML and MIS.
- This policy may be changed at the discretion of the RMS team.
With all this in consideration, it is advisable for a client to square off all positions on your own before expiry.
List of stocks with compulsory delivery are updated in this Google Sheet.