What are the risks associated with the physical delivery of stock Futures & Options (F&O)?

The physical delivery of stock derivatives can result in potential systemic risk in the Indian capital markets and pose a significant threat to traders. If a customer holds stock futures or in-the-money stock options at the time of expiry, they must give or take delivery of the entire contract's stock value. This increases the risk for clients who do not have enough cash to take delivery or stocks to give delivery. As a result, the margins required to hold a future or short option position increase as the expiry date approaches, with a minimum of 50% of the contract value or 1.5 times NRML margin (whichever is lower).

Moreover, even In-The-Money (ITM) long or buy option positions require a delivery margin four days before expiry. The margins for long ITM options increase from 10% of VaR + ELM +  Adhoc margins to 50% of the contract value, with 50% of the contract value required on the last day of expiry. The broker squares off the contract if the customer lacks sufficient funds or stocks to give or take delivery. If the customer shows an intent to hold after the higher margin is blocked, it indicates their intent to give or take delivery.

The risk, however, arises from out-of-the-money (OTM) options that suddenly become ITM on the last day of expiry. No additional margins are blocked for OTM options in the expiry week, and if they suddenly become ITM, a customer with small amounts of premium and no margin can get assigned to give or take large delivery positions, posing a significant risk to the trader and the brokerage firm.

To learn more about the risks of physical delivery of stock F&O, visit zerodha.com/z-connect/queries/stock-and-fo-queries/physical-delivery-of-stock-fo-their-risks.