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Informist, Thursday, Dec. 5, 2024

 

MUMBAI – The Securities and Exchange Board of India Thursday proposed a framework to convert in-the-money stock options into futures contracts a day before expiry. This would help mitigate the potential risks such as sudden price movements that could turn an out-of-the-money option contract to an in-the-money option while nearing the expiry day, the regulator said in a consultation paper.

 

Currently, all in-the-money options are auto exercised and converted to underlying deliverable obligations based on the volume weighted average price of the last thirty minutes of the session on expiry day. Instead of directly resulting in physical delivery obligation on the day of expiry, in-the-money stock options will initially devolve into stock futures one day before the expiry and the resultant futures positions can be closed on the expiry day, the regulator said. As a result, only futures contracts will be tradeable on the day of expiry and open positions will be settled by delivery, as is the current practice.

 

SEBI said it cannot rule out instances where an in-the-money contract turns out-of-the-money in the last few minutes or after market hours based on the volume weighted average price mechanism, though data that the regulator has analysed does not suggest major such instances.

 

On days of expiry, whether the volume weighted average price mechanism across bourses is greater or less than the strike price cannot be determined until the market closes. The system of net settlement was introduced in 2023 to address concerns regarding an out-of-the-money contract becoming an in-the-money option on the day of expiry. While this mechanism addressed the issue of a contract turning in-the-money during the day, it was not found to be helpful for contracts turning in-the-money based on the closing price.

 

Currently, the delivery margin is charged on in-the-money option contracts and none is charged on out-of-the-money strikes. "This can have a very large market impact if the price of the underlying moves even slightly during the last half an hour on expiry day," the regulator said. Also, if a trader purchases a large quantity of option contracts close to expiry, the risk can be substantial, particularly if physical delivery obligations are not met and may lead to major losses due to auction penalties if these contracts turn in-the-money.  End

 

Reported by Noopur Bhandiwad and Anjana Therese Antony

Edited by Ashish Shirke

 

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