Why were funds deducted from Zerodha account for exiting a profitable short options position?
The current market price of an option contract is called a premium. The option buyer pays the premium, whereas the option seller (option writer) receives the premium. There are two things an option writer can do after selling or shorting an option contract:
1. Exit the position by buying back the contract.
If the option writer is exiting the position by buying back the contract, the difference between the premium received and the price at which the option is bought back is the profit or the loss.
- Mr X is an option writer and sold RELIANCE SEP 2800 CE on Monday when the premium was ₹42 with 250 as the lot size.
- Mr X received ₹42 * 250 = ₹10,500 in the trading account.
- Mr X exited the short position on Wednesday when the premium went down to ₹25 and made a profit of ₹4250 [(₹42 - ₹25) * 250] by buying back the contract.
- Since Mr X already received a premium of ₹10,500 when the options were sold, ₹6250 (₹10,500 - ₹4,250) will be deducted from the funds when the position is exited (bought back).
Since the option was bought back when it was at ₹25, even though Mr X was in profit, ₹6250 was deducted from the premium received, earning a profit of ₹4250. The margin blocked for shorting the options will be released once the short position is bought back.
2. Hold the position till expiry.
If the option writer holds the position till the premium gets 0, i.e. till the expiry, they get to keep the entire premium received as a profit. However, this only happens when the position expires OTM. If the position expires ITM, then the stock options will be physically settled, whereas the index options will be cash settled. To know more, see What is Zerodha's policy on the physical settlement of equity derivatives on expiry?
From the above example, Mr X will only get to keep ₹10,500 entirely as profits if the premium becomes 0, and that will only happen if the position expires OTM.
Stock options : If the position expires ITM, then the option writer needs to do one of two things:
- Give delivery: The option writer needs to give delivery of the stock if a call option expires ITM. However, if the option writer doesn’t have the stocks in the demat account to give the delivery of the stock, there will be a short delivery, and the seller will have to pay the short delivery penalty. Visit zerodha.com/z-connect/queries/stock-and-fo-queries/consequences-of-short-delivery-nse-bse to know more.
- Take delivery: The option writer needs to take delivery of the stock if it’s a put option. However, if the option writer doesn’t have the funds in the trading account to take delivery of the stock, then there will be a debit balance in the Zerodha account.
Index options : If the position expires ITM, then the index options will be cash-settled, and the remaining amount will be debited or credited to the trading account after the trade process for the day.
To know option premium calculation for multiple trades, see How is Option Premium calculated when there are multiple trades?