Policy on settlement of compulsory delivery derivative contracts

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. 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

  1. Unexpired Futures
    • Long futures shall result in a buy (security receivable) position
    • Short futures shall result in a sell (security deliverable) position
  2. 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
  3. 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.

Our policy

Futures and Short Option (Calls & Puts) positions

  • Span + Exposure margin for all contracts which are going to be physically delivered will be increased to at least 30% or what is charged by the exchange (whichever is higher) 3 days prior to expiry or on Monday evening leading to the Thursday expiry(This will be increased to 50% on Thursday). 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.
  • So for example, if the margin required for RCOM futures is normally 25% as SPAN+Exposure of contract value, it will be 30% of contract value from Monday evening leading to expiry. Adani Power futures is 35%,  you will need to continue to maintain 35%. On Expiry day, 50% of contract value will be blocked from the account.
  • 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’.

You will be required to maintain at least 50% of the contract value on the expiry day for ITM Call options. 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.

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 RCOM July 12.5 CE and let it expire and RCOM (Stock) settles at Rs. 13, this contract will be a CTM contract. The intrinsic value of this contract will be 0.5 [13-12.5] x 28000 (lot size) = Rs 14000

Post-market closing we will check if Client’s free balance (Cash balance + Value of Stocks in Demat account + Rs 14,000) > Rs 1,02,000 (SPAN +Exposure margin for RCOM Aug future contract) or Rs 1,82,000 (50% of contract value). If client balance is lesser than Rs 1,82,000, 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.

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
  • In the event that you do not have sufficient funds to meet this obligation, interest at the rate of 0.05% per day will be charged on the debit balance.
  • 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.
  • 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, all long future contracts will be charged at 0.1% of the contract value. Long call and put positions will be charged at 0.125% of the contract value.

Additional Notes

  • 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).
  • 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.
  • This policy may be changed at the discretion of the RMS team.

You can read the FAQ on this policy here. Also, make sure to 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.

26 comments

  1. johar says:

    If I have a debit or credit spread i.e. One long call and short call of next strike price vice versa and if I let them expire, how it will be treated.?

  2. Vipin singh says:

    I have call option of Jul rcom. How I sell or square off

    • Sunny says:

      I also have call option of RCOM 25 CE.

      Out of money options (worthless ones) will not be eligible for physical delivery. So dont worry just let it expire worthless.

      But be careful of one thing, what if RCOM suddenly jumps up on Thursday, and your option becomes In the money? Just be careful on expiry day and square off your option if you can. Otherwise if its worthless and cannot be squared off, no need to worry.

    • Faisal says:

      I’m assuming you have a buy position. If it remains out of the money on expiry, it will expire worthless.

  3. Bhushan Sharma says:

    Hi ,if I have ,say KSCL,4 Lots and enough margin available in my Account even if I take 30% additional margin into account then Can I carry forward my position till expiry day not like this month Zerodha decided to auto Sq off on Monday post 12PM.

    • Faisal says:

      Yes, you can let the position expire and be physically settled, if you continue to maintain margins of at least 30% of the contract value.

  4. Ravi Chouhan says:

    Hi, Suppose I have Rcom Fut Short position and have sufficient margin to hold till expiry. If physical settlement happens, so how will its settlement process take place?

    • Ragav says:

      On Expiry day you should have shares in your demat to deliver as you are short in future, otherwise your position will be closed irrespective of margin in your account as it will result in auction settlement.

  5. Narasimha mogera says:

    I have ifci 15pe position of current month, what will happen.

  6. vilas says:

    hi i use to trade bank nifty option weekly is this applicable to same or it is applicable to only monthly expiry

    • Lindo says:

      The above is applicable only on derivatives of stocks of those 46 companies. It is not applicable on index derivatives.

  7. N VINAYA BHUSHAN says:

    I HAVE A PUT OPTION SYNDIBANK 18 AUG PE @ CMP 1.1 WHICH I WANT TO SQUARE OFF . SYSTEM IS NOT SQUARING OFF AT CMP . HOW TO SQUARE OFF .PLEASE APPRISE

  8. Varadarajan says:

    Dear concern I have bought jpassociat17.5ce July contract at 0.25 presently it went 0.05 no buyers at market now. Is it will square off immediately or it leads me to take any physical sticks please reply

    • Faisal says:

      Since it is OTM, there aren’t any buyers. The contract will expire worthless. There won’t be any delivery obligation

  9. vivek says:

    so presumably all index derivatives will continue to be cash settled bcoz theres no corresponding underlying……….

    1)will the exchange, at some point in time, change this too by requiring traders to buy a prescribed qty of the entire range of stocks that make up the index derivative?

    2)hopefully commodities, currencies, interest rate futures will remain cash settled. right?

    • Faisal says:

      1. The SEBI circular only defines Stock Derivatives to be physically settled. Physically settling whole of Nifty 50 (or other indices) stocks would cost about 50 lakhs(approx) worth of stocks. Also, exchanges around the world settle index futures in cash(we shouldn’t expect any changes in India too)
      2. Most of the commodities are cash-settled. However, MCX is moving towards settling them physically(Gold, Silver, etc) and we will see this happening for more contracts soon.
      3. Trading in foreign currency is not allowed by the RBI for retail traders, hence, physical settlement will not be possible for currencies too.

  10. Ashwani kumar says:

    Thank you for sharing contents which are very useful.

  11. Prakul says:

    HCC spot = 12

    I write 1 lot of HCC 20CE @ 0.10

    If on expiry 3:30pm HCC closed at 15.

    So, whether I need to give physical delivery or not?

    • Faisal says:

      Unless HCC crosses 20, the calls will remain OTM and you do not have to give delivery(The contracts will expire worthless)

      • Prakul says:

        But, I got mails 2-3 times from support & RM team of Zerodha.

        Also, I call to Zerodha….

        They told me compulsory physical delivery needed even if option expires worthless.

        Unfortunately, I closed corresponding position.

        • Faisal says:

          Prakul, I believe our Support team informed you to maintain additional physical delivery margins(explained in the post above) as you kept holding the position till expiry.

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