The National Stock Exchange (NSE) has announced the discontinuation of the ‘do not exercise’ facility for stock options on the expiry date. The circular released on January 20, 2023, stated that the facility would be withdrawn from the March 2023 expiry of F&O contracts. The ‘Do Not Exercise’ facility, which was re-introduced in 2022, allowed traders to instruct brokers not to exercise their right to give or receive deliveries. However, with its removal, traders will now have to take delivery of shares if an option contract becomes in-the-money (ITM), and the contract has not been squared off on the expiry day.
How it Works
When an option contract’s price of the underlying asset surpasses the strike price of the option, it is considered to be in-the-money (ITM). Conversely, an option contract is out-of-the-money (OTM) if the price of the underlying asset is below the strike price. Suppose a trader buys an out-of-the-money call option contract with a strike price of Rs 500 when Hindalco’s stock price is Rs 480. In that case, the option will be profitable only if the stock price rises above Rs 500 before the option’s expiration date.
If Hindalco’s stock price rises to Rs 501 before the option’s expiration date, the option becomes in-the-money as the stock price has surpassed the strike price of Rs 500. The trader can exercise the option and purchase shares of Hindalco at the strike price of Rs 500, then sell them on the open market for Rs 501, resulting in a profit of Re 1 per share (minus the premium paid for the option). However, traders typically do not exercise the option as the profit will be negligible after accounting for brokerage fees and other costs. Instead, they choose the ‘do not exercise’ option and settle for cash.
With the removal of the ‘do not exercise’ facility, option traders who have not squared up their in-the-money call positions will have to take delivery or give delivery of shares based on the type of contracts they have bought or sold.
Implications
This change has significant implications for traders. According to a SEBI-registered investment advisor and trader, traders will have to monitor their screens vigilantly in the last hour of expiry day volatility. They will have to square off positions on time, or they will end up getting delivery of the shares. Traders might have to put in more margin money in the last week of expiry to hold positions where the underlying asset’s price is close to the contract’s strike price.
In addition, the removal of the ‘do not exercise’ facility means that option buyers now have an obligation rather than a right. This has increased the risk of significant losses, particularly if out-of-the-money options become in-the-money, and there is no liquidity to exit. Brokers also face challenges, as they must square off customer positions beforehand to avoid auctions that customers will not bear.
