13.1 Overview

Until recently, futures and equity options were settled in India in cash. This means that buyers and sellers could settle their positions in cash after the expiry of the contract. They did not have to take delivery the underlying security. SEBI issued a circular on April 11, 2018 making all stock F&O contracts obligatory for physical delivery in a gradual manner. This circular was issued to reduce excessive speculation that could lead to too much volatility in individual stocks.

13.2 What is Physical Settlement, and How Does It Work?

This means that all stock F&O contract expiry dates must be fulfilled. All stock F&O contract expiry dates are October 2019.

Let's look at an example. Before physical settlement was introduced, if you only bought a few SBI futures that expire this month, your contract will be cash-settled according to the settlement price. You will receive the debit or credit in your trading account.  We've described how marked-to-market settlement works. However, with physical settlement, if your position isn't closed or rolled over before expiry, you must pay the entire contract. You will then receive shares to your Demat account.

13.3 What is the purpose of Physical Settlement?

Cash-settled contracts do not require traders to maintain margins. This can cause short-sellers to build up excessive short positions close to expiry, artificially driving down the price. To deliver the stocks to their counterparties, the traders will need to either buy stock on the equity markets or borrow money from the SLB market. This ensures that the price is balanced and does not allow for price manipulation.

13.4 How do positions get settled?

Various F&O contracts expire and are then settled in the following way

1. Take Delivery (stocks are delivered directly to your Demat account).
2. You are required to deliver stocks to the exchange.

Only ITM options can be physically settled. If an option expires OTM they will expire in vain and there will not be any delivery obligation.

13.5 Netted off positions(subcategory)

Multiple positions of the same underlying with the same expiration date will form a hedge. They will be netted off depending on which direction they are.

If you have an SBI June ITM Put of strike 200 and a long futures contract with SBI, the long futures position will result in a take delivery obligation. The long option will also lead to a delivery obligation. These will be credited to your account, and there won't any physical delivery obligations.

13.6 Margins

F&O trading requires that you only keep the margin amount in your account for short and future options. Long options require you to hold the premium to buy. This is not true for physical settlement. You will need to bring in 100% or stocks to deliver the contract. When such positions are closer to expiry, brokers add margins.