As a trader, have you ever wondered – “What Happens If I Don’t Square Off Options On Expiry?”
In India, there are 2 segments in which you can trade in stock markets. First, the futures and options (F&O) market. And second, the cash market.
However, there is also a third market, which is the IPO market. But you cannot trade here since you can only buy. Selling can only happen when the stock gets listed on the secondary market.
Let us quickly differentiate between the cash market and the F&O segment. Let’s say you decide to buy any product. So, you can either pay for this purchase by cash or by credit card.
Similarly, in the cash segment, you have to pay the entire amount in cash. After the payment, you get the shares in your Demat account.
Position Sizing In Cash And Derivatives Market
In the futures segment, if you buy/sell a certain quantity of shares, you have to pay only a margin amount. You then have to square off the position and sell/buy an entire lot of shares.
Therefore, in the futures segment, there is very high exposure as you cannot trade in small quantities (a minimum 1-lot position needs to be taken. On the contrary, in the cash market, you can even buy 1 share.
There is another major difference between these 2 markets. In a futures market, you have to sell or square off the position (upon expiry of the contract), whereas, in the cash market, you get to keep the shares for your entire lifetime.
However, since the working of the futures and options market is quite complex (or is presumed to be), people are quite hesitant to operate in this market.
One question that pops up in their mind is, “What happens if I don’t square off options on expiry?” “What can be the consequences for the same?”
Therefore, this article will help you address such questions. It is of utmost importance to understand these questions before you place a trade in the futures and options market. Read on to find out!
Futures And Options Market – What Is It?
Price fluctuation is the only thing that is certain about financial and commodity markets.
It keeps on changing all the time. Prices tend to go up and down due to the impact of several factors such as the state of the economy, weather, agricultural production, results of the company, etc.
Therefore, individuals who deal in such markets are concerned about such fluctuations. Simply put, a derivative is a contract that derives its value from underlying assets. Underlying assets can include stocks, commodities, currency, etc.
One type of derivative contract is the futures contract. In such a type of contract, the buyer decides to buy a certain quantity of an asset at a specific price at a future date.
Futures as a trading instrument is used by hedgers, speculators, and arbitrageurs. Hedgers can be referred to as the primary participants in futures markets.
To minimize the effects of changes (i.e., changes in commodity prices or exchange rates), hedgers tend to utilize futures contracts. Hedgers are individuals or firms who use futures markets to manage and offset risk.
On the other hand, a speculator is any individual or firm which accepts risk to make a profit. Speculators get such profits by buying low and selling high.
An arbitrageur is a type of investor who tries to profit from market inefficiencies. They tend to exploit price inefficiencies as they enter simultaneous trades which offset each other to get risk-free profits.
Another kind of derivative contract is an options contract. Options are a little different from futures contracts. Options give a buyer the right, but not the obligation, to purchase a particular asset at a particular price at a specific pre-decided date.
There are 2 types of options: call option and put option. Call Options to give you the right to buy and put options give you the right to sell the underlying asset upon expiration.
Let us now try to understand the basic question which gets popped up at the time of expiry, “What happens if I don’t square off options on expiry?”
Squaring Off Options On Expiry
In the Indian equity market, the last Thursday of every month is considered the expiry day for monthly futures and options. Traders are required to settle their positions on or before the arrival of the expiry day.
Nifty and Bank Nifty Index have both weekly and monthly expiries. Weekly contracts expire every Thursday.
Traders believe that it is safe to trade options on expiry day. However, it is of utmost importance to know the correct way for executing options trades and the right range within which the market can expire.
Let us now look at the answer to the question, “What happens if I don’t square off options on expiry?” In simple words, the stock options contract is bound to be physically settled if it is in the money.
Therefore, you will be obliged to receive or deliver the shares depending on the position you have taken. On the other hand, if your option expires out of the money, it will expire worthlessly.
In the case of Index options (i.e., Nifty, Bank Nifty, etc.), if the option expires ITM, they will be cash-settled. However, if your options expire out of the money, they will expire worthlessly.
What happens in the case of contracts where delivery-based physical settlement does not take place? If you have bought options in the money, STT on exercised contracts will be charged @ 0.125% of intrinsic value, and not on total contract value.
If a trader has shorted options, STT for options gets levied only on the sell side. Therefore, STT would’ve been levied when initiating the short. As a result, there will be no STT impact on expiry. According to the moneyness of an option contract, that trader gets to keep premiums received.
To Sum Up
It is of utmost importance to know the day of expiry of all futures and options contracts. Traders are required to be mindful of this deadline to avoid fines, principally if the trading is being done in futures contracts.
Expiry date gets heavily monitored by the arbitrage traders as they might turn to F&O markets to improve profitability. Every stock trader needs to understand how the expiry date can affect the stock market as a whole.
After looking at increased volatility near the expiry date, an investor can decide to book short-term profits or he/she can avoid trading to reduce losses.
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