Think of a derivative contract as a promise, some promises are settled with cash, where only the profit or loss are exchanged. But others require you to exchange the actual item. In the stock market, this is called physical settlement.
If you hold certain stock contracts until their expiry, you must either buy or sell the actual shares. This can be a huge surprise if you’re not ready, let’s get straight into All About physical delivery in Futures and Options. This blog gives you the essential knowledge about physical delivery in Futures and Options to help you trade smarter.
What is Physical Settlement?
Physical settlement means that when a stock derivative contract expires, you don’t just settle the profit or loss in cash. Instead, the actual shares are transferred between the buyer and seller.
- If you have to buy, you must pay the full value of the stock and get the shares in your demat account, this is called taking delivery.
- If you have to sell, you must have the shares in your demat account to give away, this is called giving delivery.
This rule only applies to derivatives on individual stocks. Index contracts like the Nifty 50 are always settled in cash, since you can’t deliver an index.
SEBI introduced this rule to make the markets safer and fairer. The main goals were to:
- Reduce risks: Knowing you might have to buy shares worth lakhs makes you trade more carefully.
- Stop price manipulation: It’s much harder to manipulate prices when you have to actually arrange for shares or full payment.
- Align with global standards: This brings the Indian market in line with major international markets.
Read Also: Difference Between Options and Futures
Positions Marked for Physical Settlement?
If you hold any of these positions until the market closes on expiry day, you are on the hook for physical settlement.
For Futures Contracts
Any open stock futures position at expiry will be physically settled.
- A Long (Buy) Future means you must take delivery (buy the shares).
- A Short (Sell) Future means you must give delivery (sell the shares).
For Options Contracts
For stock options, settlement only happens if your option is In-the-Money (ITM) when it expires. If it’s Out-of-the-Money (OTM), it just expires worthless with no further obligation.
The exchange automatically assumes you want to exercise your ITM option, so you must act if you want to avoid it.
Obligations
This table makes it clear what you have to do.
| Contract Position | Your Obligation at Expiry | Simple Meaning |
|---|---|---|
| Long Stock Futures | Take Delivery | You must buy the shares. |
| Short Stock Futures | Give Delivery | You must sell the shares. |
| Long ITM Call Option | Take Delivery | You must buy the shares. |
| Short ITM Call Option | Give Delivery | You must sell the shares. |
| Long ITM Put Option | Give Delivery | You must sell the shares. |
| Short ITM Put Option | Take Delivery | You must buy the shares. |
How is it calculated?
The final transaction value is not based on your trade price. It’s calculated using a specific price on expiry day.
- For Futures: The settlement happens at the Final Settlement Price (FSP), which is the average price of the stock in the last 30 minutes of trading on expiry day. Example: Let’s say you have 1 lot of ABC Ltd. futures (lot size 500 shares). On expiry day, the FSP of ABC Ltd. is calculated to be Rs.1,200. Your obligation is to pay the full contract value, which is 500 × Rs1,200 = Rs 6,00,000, to take delivery of the 500 shares.
- For Options: The settlement happens at the Strike Price of your option contract. Example: Let’s say you have 1 lot of an ABC Ltd. call option with a strike price of Rs.1,150. The stock closes at Rs.1,200 on expiry, so your option is ITM. Your obligation is to pay the value calculated using the strike price, which is 500 × Rs 1,150 = Rs 5,75,000, to take delivery of the 500 shares.
This is a crucial point. Your F&O profit might be small, but your settlement obligation could be for lakhs of rupees. Don’t confuse the two.
| Contract Type | Settlement Value Is Based On |
|---|---|
| Stock Futures | Final Settlement Price (FSP) of the stock |
| Stock Options | Strike Price of the option contract |
Read Also: Types of Futures and Futures Traders
Settlement Timeline and Deadlines
The physical settlement process starts at the end or during the week of expiry.
- The Final Week: In the last four days before expiry, exchanges start increasing the margin required for long ITM options. This is a signal to either close your position or arrange for funds.
- Expiry Day: This is your last chance to act, as most brokers have a cut-off time (often around noon) to square off positions. If you don’t act, and don’t have the required funds or shares, your broker will close the position for you to manage their risk.
- After Expiry (T+1 Day): The actual shares and funds are exchanged. Shares are credited or debited from your demat account.
Always check with your broker for their specific deadlines, as they can vary from broker to broker.
The Margin Squeeze
To enter an F&O trade, you pay a small margin. But for physical settlement, you need 100% of the contract value, either in cash to buy the shares, or the actual shares in your demat account to sell them.
To manage risk, exchanges force you to face this obligation early. They do this by gradually increasing the margin requirement on long ITM options in the last few days before expiry. This “staggered” margin increase makes traders exit, who can’t afford the full settlement, preventing a wave of defaults on the final day. If you can’t meet these increasing margin calls, your broker will likely close your position.
Read Also: What Is Day Trading and How to Start With It?
Conclusion
Physical settlement is a fundamental part of the market that you must respect. Being unprepared can be very costly.
Smart investors shall be aware and shall always know your open stock F&O positions as expiry week begins. Understanding if you need to buy or sell shares if you hold your position, means knowing your obligations and also keeping an eye on margin requirements, as they will shoot up in the final week. And finally act in time if you don’t want to take or give delivery, square off your position before your broker’s cut-off time.
By understanding these simple rules, you can navigate expiry week confidently and avoid any nasty surprises.
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Frequently Asked Questions (FAQs)
How can investors avoid physical settlement?
The easiest way is to close (square off) your open stock F&O position before it expires and before your broker’s cut-off time. For futures, you can also roll over your position to the next month.
What happens if investors have to sell shares that they don’t own?
This is a “short delivery.” The exchange will buy the shares for you in an auction, and you have to pay the auction price plus a penalty, which is often very expensive.
What happens if I have to buy shares but don’t have enough money?
Your account will go into a negative balance, and your broker will charge you interest. The broker can also sell the shares delivered to you to recover the amount. You will be liable for any loss and charges.
What are the charges for physical settlement different?
Yes. Brokerage is typically higher (e.g., 0.25% of the settled value). Also, the Securities Transaction Tax (STT) is much higher, at the rate applicable for equity delivery (0.1% of contract value).
Does this apply to Nifty and Bank Nifty contracts?
No. Physical settlement is only for stock derivatives. All index F&O contracts are settled in cash.
