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What is Zerodha's policy on the physical settlement of equity derivatives on expiry?

As stated in this SEBI circular, starting 26th July 2018, F&O positions in the stocks mentioned in these NSE circulars (FAOP37594 & FAOP38657) 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.  

Note: Some of the scrips in NSE's original list have been discontinued from trading in F&O. NSE also introduces new scrips to be physically settled from time to time. Check this list to stay updated on stock derivatives which are to be compulsorily settled physically.

Futures and Short Option (Calls & Puts) positions

1. Span + Exposure margin for all contracts which are going to be physically delivered will be increased to at least 40% or what is charged by the exchange (whichever is higher) 3 days prior to expiry or on Monday leading to the Thursday expiry (This will be increased to 80% on Thursday). These margins will be debited on your trading ledger.

DayPercentage of Contract value that will be blocked
Expiry - 3 days (Mon)40%
Expiry - 2 days (Tue)50%
Expiry - 1 day (Wed)60%
Expiry day (Thu)80%

2. These margins debits will be shown on your trading ledger. The increase in margin is to cover for the additional obligation that will arise if these contracts are held till expiry and result in a physical settlement. If the SPAN +Exposure margin is higher than the above-mentioned margins, the exchange margin will be levied.
3. So for example, if the margin required for Allahabad Bank futures is normally 25% as SPAN+Exposure of contract value, it will be 40% of contract value on Monday leading to expiry.
4. 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.

5. In the event that you do not fulfil 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’.

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.

Blocking of Delivery Margins

The exchange has mandated that even long call and put options will require margins to be blocked starting from the September expiry. The margins will be applicable 4 days before expiry.  This will be charged as a percentage basis on the applicable VaR + ELM of the underlying contract. Additionally, starting from February 2019 expiry, we will be blocking margins as a percentage of the contract value(or SPAN+Exposure, whichever is higher) in the following order-

DayPercentage of Contract value that will be blocked
Expiry - 3 days (Mon)40%
Expiry - 2 days (Tue)50%
Expiry - 1 day (Wed)60%
Expiry day (Thu)80%

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 along with the applicable margins mentioned above.

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. All OTM options will expire worthless. There will be no delivery obligations arising out of this.
In the event that you do not fulfil these margin obligations on time, your positions are liable to pay margin penalty  & it may be squared off at the discretion of our RMS team. Any loss arising out of such square off would be the sole responsibility of the client.

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 Stock depending on whether you have written a call/put option.

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

You are required to bring in funds if your account results in a debit balance after physical delivery failing which the delivered shares will be liquidated to make good of the debit balance.

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 based on the direction of the Hon’ble Bombay High Court, all physically settled contracts(both Futures and Option) will carry an STT levy of 0.1% of the contract value for both the buyer and the seller of the contract.

Additional Notes 

  • No BTST transactions shall be allowed for stocks received by means of physical settlement.
  • 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.
  • This policy may be changed at the discretion of the RMS team.
Refer to this post for more information on delivery-based settlement.