Understanding Physical Settlement for Option Buyers

Is the buyer of an option subjected to Physical Settlement?

In short, Yes! SEBI guidelines stipulate that all In The Money (ITM) stock options contracts undergo physical settlement, regardless of the buyer or seller status.
For the Call Option Buyer:

Mr. Man, a FYERS client, acquired one lot of Tata Motors 500 CE at a ₹10 premium each. When he made the purchase, Tata Motors traded at ₹480. With the lot size of Tata Motors being 1425 Qty, he let his contract expire. As time progressed, Tata Motors surged to ₹530 by expiry, marking it ITM.
This puts Mr. Man in a predicament. He can:
  1. Deposit ₹7,12,500 (₹500*1425 Qty), the entire contract value, into his trading account 5 days prior to expiry.
  2. Alternatively, exit or square-off his Tata Motors 500 CE position at least 5 days before expiry.
Failure to meet these requirements might compel our risk team to square off the position on Mr. Man's behalf. Additionally, not maintaining the necessary margins may incur penalties.
Post-Expiry Outcomes (After adding the funds): After the contract's expiry, the exchange will credit the underlying Tata Motors shares to Mr. Man's Demat account, post the deduction of the contract value of ₹7,12,500.
For the Put Option Buyer:

Ms. Kani, another FYERS client, bought one lot of Tata Motors 500 PE for a ₹10 premium each when the stock traded at ₹520. She chose to let her contract expire. However, Tata Motors' value declined to ₹470 by expiry, making it ITM.
Ms. Kani now has three choices:
  1. Deposit ₹7,12,500 (₹500*1425 Qty), the entire contract value, into her trading account 5 days before expiry.
  2. Ensure she possesses 1425 Qty of Tata Motors in her Demat, ready for physical settlement delivery.
  3. Opt to exit or square-off her Tata Motors 500 PE position at least 5 days before expiry.
Failure to meet any of the above could result in our risk team squaring off the position on Ms. Kani's behalf. And, if necessary margins aren't met, she may face penalties.
Post-Expiry Scenarios (After adding funds/maintain shares):
On the contract's expiry, the exchange might: Deduct the contract value from Ms. Kani’s trading account, buy the shares in the open market, and then transfer the shares to the option seller's Demat. (This applies when Ms. Kani has added funds).
Deduct 1425 Qty of Tata Motors from Ms. Kani's Demat and then transfer it to the put option seller. (This applies when Ms. Kani had the shares in her Demat).
For an in-depth dive into physical settlements, consider checking out our comprehensive blog.


    • Related Articles

    • Can an option buyer exercise their right any time during the contract's duration?

      No, the option buyer is only able to exercise their right upon the contract's expiry. For instance, Ms. Mehta acquires a put option for Bajaj Auto with a ₹3,000 strike price, set to expire in three months. Even if Bajaj Auto shares drop to ₹2,900 ...

    • When does the buyer & seller of a call option benefit in the stock market?

      The buyer of the call option benefits when the underlying asset's price is above the strike price at the contract's expiry. Conversely, the seller gains when the price remains below the strike price at expiry. For instance, Mr. Verma buys a call ...

    • How can I rollover a contract to avoid physical settlement?

      Rollover refers to the process of transferring your position from the near-month expiry contract to the next month's expiry contract, typically on the expiry day. By doing this, you're essentially closing your current position and simultaneously ...

    • What does 'X' settlement or cash settlement mean in trading?

      In trading, settlement refers to the process by which securities are transferred from the seller to the buyer. However, there are times when the delivery of these securities faces disruptions. Here's a look at how 'X' or Cash Settlement comes into ...

    • What is a call option?

      A Call Option is a derivative contract that gives the buyer the right (but not the obligation) to purchase an underlying asset at a predetermined price by a certain date. Effects of Buying a Call Option: By buying, you secure the right to purchase ...