6 F&O strategies to deploy ahead of expiry on Thursday

Shubham Agarwal
Quantsapp

After the regulator guided, it was clear that we had the physical settlement of Equity Derivatives in site. Here we are now with the first phase of the Physical Settlement with a set of 46 stocks required to be settled physically from the upcoming expiry on July 26.

Now, it becomes very important for us participants to understand how it will work. I have jotted down the mechanism of physical settlement with few illustrations hope it would clear the air.

We will start with who is obliged to deliver, what quantity and at what price. Then we will go through some cases to understand it better.

Delivery Obligation

Futures:

All Open positions( Long futures or Short Futures) left on expiry post trading hours on Expiry day will be eligible for Physical settlement.

Options:

All ‘In the Money’ options (ITM Call or ITM Put) that are left to expire and should ideally get settled in cash the following day will be eligible for Physical settlement. However, in respect of Close to Money (CTM) option contracts the option holder shall have a facility of do-not-exercise.

Now, what are Close to Money Options?

> Call Options - 3 ITM options strikes immediately below the final settlement price

> Put Options - 3 ITM options strikes immediately above the final settlement price

All other Options in the sense, ATM or OTM do not entail any further settlement, thus no physical delivery requirement. In other words these are the ones that end up to be zero on the day of expiry.

Let’s understand it with an illustration; conceptually following table explains the moneyness option best.

Where,

S= Final settlement price on expiry day

X= Strike

Now let’s take an example, Just Dial final Settlement price on July 26 is 575 then options’ moneyness will look something like this:

Delivery Quantity

To get the grip of understanding of physical settlement, we need to go back to our “Basics of Options”

Also, when we have to give delivery or take delivery in options, it amount to total quantity i.e.

Market lot * number of contracts

Netting of Quantity

Final commitment of receiving stock/providing delivery would be on net basis taking combine future and option positions for a particular stock for same expiry.

Price

Futures:

Final Settlement price of the futures contract on expiry day.

Options:

Relevant strike price of the option contract (Call or Put) in which position is held long or short

Illustrations:

Mr Amit has positions in Future and Options in Just Dial. Assume: Just dial close at Rs.575 on 26th July expiry (Lot size of Just dial is 1400). Let’s evaluate various possibilities

Note:
Qty (Positive: Receive delivery; Negative: give delivery)

Value (Positive: Money inflow; Negative: money outflow)

Strategies:

(VI) Key Takeaway

> Trader needs to be cautious in stocks which are compulsory in physical delivery mechanism by squaring/rolling the contract well before expiry to avoid huge obligation of providing delivery/ cash outflow
> If trader fails to square off ITM ( Long or short )option and is incapable of providing delivery/ Cash outflow then he/she would face huge penalty /auction requirement

> In case of Options where traders deal in multiple lots, obligations could be high. Thus retail traders need to be extra cautious

Disclaimer: The author is CEO & Head of Research at Quantsapp Private Limited. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.