Will Physical settlement apply to the buyer of an option?

Will Physical settlement apply to the buyer of an option?

In short, Yes! As per the SEBI guidelines, In The Money (ITM) stock options contracts are due for physical settlement irrespective of the nature of the transaction. 


Still unclear? Let us take a look at the implications of physical settlement from the perspective of the Option Buyers.


  1. Call Buyer: Let’s say, Mr. Man, a client of FYERS, has bought one lot of Tata Motors 500 CE at a premium of ₹10 each. Tata Motors was trading at ₹480 at the time of purchase, and Tata Motors lot size is 1425 Qty. Mr. Man decides to let his contract expire. However, over time, the price of Tata Motors increased to ₹530, making it ITM just before the expiry attracting physical settlement.

    Mr. Man has been put on the spot and has two options:


  • He has to transfer the entire contract value of ₹7,12,500 (₹500*1425 Qty) into his trading account at least 5 days before the expiry. 

Or

  • He is required to square-off/exit the open position of Tata Motors 500 CE at least 5 days before the expiry.


If Man isn’t meeting any of the criteria mentioned above, our risk team will act upon and square off the open position. Also, if the necessary margins are not maintained, penalties will be levied on the shortfall amount.


Expiry implications (After adding the funds): On the expiry of the contract, the exchange will deliver the underlying shares of Tata Motors into Mr. Mani’s Demat account after debiting the contract value of ₹7,12,500.


  1. Put Buyer: Let’s say, Ms. Kani, a client of FYERS, has bought one lot of Tata Motors 500 PE at a premium of ₹10 each. Tata Motors was trading at ₹520 at the time of purchase, and Tata Motors lot size is 1425 Qty. Ms. Kani decides to let her contract expire. However, over time, the price of Tata Motors dropped to ₹470, making it ITM just before the expiry attracting physical settlement.

    Now, Ms. Kani has been put on the spot and has three options:


  • She has to transfer the entire contract value of ₹7,12,500 (₹500*1425 Qty) into his trading account at least 5 days before the expiry.

Or

  • She must have 1425 Qty of Tata Motors in her Demat in order to deliver the shares on physical settlement.

Or

  • She is required to square-off/exit the open position of Tata Motors 500 PE at least 5 days before the expiry.


If Kani isn’t meeting any of the above-mentioned criteria, our risk team will act upon and square off the open position. Also, if the necessary margins are not maintained, penalties will be levied on the shortfall amount.


Expiry implications (After adding the funds/shares): On the expiry of the contract, the exchange will:

  • Debit the contract value from Ms. Kani’s trading account, Buy the shares in the open market and deliver the shares into the Demat of the seller of the option. (When Kani transferred funds)

  • Debit the 1425 Qty of Tata Motors and deliver it to the put option seller. (When shares are available in her Demat).


Note: For more information on physical settlement, kindly refer to this blog.