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.


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