Physical Delivery Settlement & Margin Requirement on Stock Option Contracts5 min read
When you buy or sell an option contract, it reflects as an open position in your account. If it is an overnight product, this position gets closed only at expiry or if you take an opposite position (sell/buy) of the same magnitude (lot size) at any time before expiry. If you exit the open position any time before expiry, you will be able to settle it in cash. But, just in case you wish to wait till expiry, the settlement process varies for indices and stock options.
For indices, SEBI mandates that the index futures and options will be cash settled while for stock futures and options, it will be mandatorily physically settled on expiry. You can find the circular here.
Physical settlement requires the derivatives traders to deliver or receive the entire contract value of shares. Let us understand this with the help of a few scenarios.
Scenario 1: Let’s say, you bought 3 lots of TCS Put option for a strike price of Rs. 3800. Now the underlying price of TCS at expiry is below strike (let’s say 3750), then your option is In-The-Money and will get exercised. To physically settle this, you will have to provide delivery of 450 (3 lots x 150 lot size) TCS shares at strike price.
Scenario 2: In another situation, let’s say you bought 2 lots of Reliance 2200 Call option and the underlying price of Reliance at expiry is above strike (let’s say 2300), then your option is In-The-Money and will get exercised. To physically settle this, you will be obligated to take delivery of 500 (2 lots x 250 lot size) Reliance shares at strike price by maintaining funds worth 11 lakhs (500 shares x 2200 strike) in your account.
Long futures and short positions on ITM Put options are treated similar to the long positions on ITM Call options where funds worth the contract value have to be maintained to facilitate physical delivery. Similarly, short futures and short positions on ITM Call options are treated like long ITM Put options where holdings worth the total share quantity have to be maintained in the demat account.
In short, if you opt for physical settlement on expiry,
At the time of buying options, the funds blocked in your account would be equal to the option premium which is a small amount when compared to the actual contract value.
If we assume option premium of Rs. 75 and Rs. 50 respectively in scenarios 1 and 2 above, we can see how:
This huge difference in these two values is the reason for which exchange has defined certain additional margins for physical delivery that are applicable from E-4 day where E is day of expiry.
Short positions on option stock are similar to futures in terms of initial margin requirements and hence do not have any additional margin requirement for physical delivery.
What Is Paytm Money’s Policy On Physical Delivery Of Stock Option Contracts?
In line with the Exchange guidelines, our Risk Management team has the following policy on physical delivery settlement & margin requirement on option stock contracts:
Additional margin will be charged for Stock Option Net Long ITM contracts as below:-
For Expiry – 4 day 10% of (VAR + ELM + Adhoc Margin of Scrip * Qty * Strike Price)
For Expiry – 3 day 25% of (VAR + ELM + Adhoc Margin of Scrip * Qty * Strike Price)
For Expiry – 2 day 45% of (VAR + ELM + Adhoc Margin of Scrip * Qty * Strike Price)
For Expiry – 1 day 70% of (VAR + ELM + Adhoc Margin of Scrip * Qty * Strike Price)
Expiry day 100% of (VAR + ELM + Adhoc Margin of Scrip * Qty * Strike Price)
Further, to inform you that the client needs to maintain / provide delivery margins by T+1 day or else it would fall under margin shortfall & shall be included in the client margin reporting, accordingly penalty will be charged.
Moreover, there is a brokerage of 0.5% of the contract value that we charge to facilitate physical delivery of stocks in case the client opts for it.
How Does It Impact You?
If you have any open long positions on ITM and NTM (Near-The-Money) strikes approaching expiry, you will get intimation through various communication channels like Email, SMS or Push notifications, to maintain sufficient funds in order to satisfy the additional margins required for physical delivery obligation. If you do not maintain the required funds in your account, your position will be auto squared off by our Risk Management team.
If you wish to take fresh long positions near expiry on ITM or NTM strikes, you will have to provide high margins to proceed with the order. This higher amount will be due to the additional physical delivery margin apart from the option premium.
What About OTM (Out-The-Money) Options?
Additional margins are not required for deep OTM options. But the underlying stock price might change drastically in one direction during the expiry week, converting few OTM strikes to ITM strikes, so our Risk Management team will square off such positions as and when they discover it and find insufficient funds to continue that position. Also, you will not be allowed to take any fresh positions on E-1 and E (Expiry) day.
- There is an additional margin required for opening or carrying a long position to expiry on ITM and NTM option stock to satisfy physical delivery obligation.
- Clients can square off or rollover to next month any open positions on long ITM option stock contracts to avoid any margin shortfall penalty or losses arising out of auto square off.
- No fresh positions are allowed starting from Expiry-1 day till Expiry day.
Disclaimer: Investments in the securities market are subject to market risks, read all the related documents carefully before investing. The securities quoted are exemplary and are not recommendatory. This content is purely for educational, information and investor awareness purpose only. Paytm Money Ltd SEBI Reg No. Broking – INZ000240532. NSE (90165), BSE(6707) Regd Office: 136, 1st Floor, Devika Tower, Nehru Place, Delhi – 110019