Physical Settlement of Derivatives: A Brief

SEBI had (read NSE circular at issued a diktat in March 2018 to align the cash and derivative segments of the market, through physical settlement for all stock derivatives in a phased manner and had , to start with, identified 46 stocks for compulsory delivery.

By introducing such measures, their intent may be to encourage derivative traders to move to cash segment to attempt (to improve STT revenues some say while others say it is to correct the anomalous situation where derivatives turnover as % of total in India is far more skewed than other markets) . Some also cite excessive speculation in F&O segment as a probable cause .

How it will work

This mechanism is already present in the commodity markets and has now been extended to equity derivatives as well. The current experience in the MCX on such contracts suggests that most traders prefer cash-settled contracts, as they square off their current month positions much ahead of the last five days and enter into fresh positions in the ensuing month.

Essentially, If you don’t square off your positions before the end of the July 2018 expiry day, you will either have to take delivery (for long futures, long calls, short puts) or give delivery of the underlying stock (short futures, long puts, short calls) for the contract.  Either you should have  delivery of these or you may move to the SLBM segment to borrow these – which looks tough given the small scattered size of this market but which may surely get a push.  This means you need to have your cash or delivery ready before then as post expiry day, these need to be settled on T+2. If not, large closeout or auction penalties will be levied as usual in cash segment.

Effectively, the expiry day inaction will mean you did a cash trade for all practical purposes and will have to cough up the settlement amounts by the 3rd day.

So the next time you are entering a trade in the identified contracts, do keep in mind what you might end up committing if you don’t square these up – work closely with your advisor to avoid last minute issues and unnecessary penalties!




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