What are the risks associated with the physical delivery of stock Futures & Options (F&O)?
Physical delivery of stock F&O can potentially lead to systemic risk in the capital markets and pose a risk to traders.
If a client holds stock futures or any in the money stock option at the close of expiry, they have to give or take delivery of the entire contract value worth of stocks. Since the risk goes up with respect to the client not having enough cash to take delivery or stock to give delivery, the margins required to hold a future or short option position goes up as we get closer to expiry. Margins required are a minimum of 40% of the contract value on the last two days of expiry.
Even for in the money long or buy option positions, a delivery margin is assigned from 4 days before expiry. The margins for long in the money options go up from 10% to 50% of contract value - 50% on the last two days of expiry. If the client doesn’t have sufficient funds or stocks to give or take delivery, the broker squares off the contract. If the customer shows an intent to hold after the higher margin is blocked, it shows an intent to give or take delivery.
The risk though comes from out of the money options that suddenly turn in the money on the last day of expiry. No additional margins are blocked for OTM options in the expiry week, and when it suddenly turns in the money, a customer with small amounts of premium and no margin can get assigned to give or take large delivery positions, causing significant risk to the trader and the brokerage firm.
Read this Zconnect post where our CEO has elaborated on the risks of physical delivery of stock futures & options (F&O).