Understanding Physical Settlement in F&O

CA Manish Singh: Hello everyone, and welcome to the final chapter of this Technical Explainers series. Throughout all previous chapters, we repeatedly used one term: expiry. But what actually happens on expiry day? How are these contracts settled? Today we will understand this clearly. 

Let us begin. 

Two Types of F&O Contracts 

There are two categories of instruments that expire: 

1. Index contracts
2. Stock contracts 

Both expire, but the settlement mechanism is completely different. 

1. How Index F&O Settles (Cash-Settled) 

Index contracts – whether Futures or Options – are always cash-settled. 

This means: 

• Whoever made a profit receives the profit in cash.
• Whoever incurred a loss pays the loss in cash.
• There is no physical movement of any asset except money. 

Example: 
If you made ₹10,000 profit, someone else made ₹10,000 loss. 
The exchange collects the loss and credits the profit. 
This is how index settlement works. 

Key point: 
At 3:30 pm on expiry, every liability ends. 
There is no delivery in index F&O. 

2. How Stock F&O Settles (Physical Delivery) 

For stocks, the rules change completely. 

Stock Futures and Options now operate under compulsory physical settlement. 

This means: 

If you hold a Futures Buy position till expiry: 

You must arrange funds to take delivery of the stock. 
You will receive the quantity defined in the lot size. 

If you hold a Futures Sell position till expiry: 

You must deliver the shares from your demat account. 

So, if you are long or short in a stock future at 3:30 pm on expiry, 
you are signalling an intent to take or give delivery. 

3. Stock Options: When Delivery Obligation Applies 

Earlier, we learnt that any bullish position can be created via: 

• Buying a Call, or
• Selling a Put 

Similarly, bearish positions come from: 

• Selling a Call, or
• Buying a Put 

Each of these can create a delivery obligation at expiry depending on whether the option expires In the Money (ITM) or Out of the Money (OTM). 

Let us simplify this. 

A. If You Are Bullish: Call Buy or Put Sell 

Scenario 1: Call Buyer 

If your Call Option expires OTM 
(e.g., Stock is ₹1500, your strike is 1510) 
→ The option becomes zero. No delivery. 

If your Call Option expires ATM or ITM 
(e.g., strike 1500, stock closes at or below 1500) 
→ You must take delivery of the stock. 
Funds must be arranged to purchase the lot size. 

Scenario 2: Put Seller 

If your Put Option expires OTM 
(e.g., strike 1490, stock expires at 1500) 
→ Premium becomes zero. No delivery. 

If the Put expires ITM 
(e.g., stock closes at 1480) 
→ You must take delivery, because the Put buyer will exercise the right to sell. 

B. If You Are Bearish: Call Sell or Put Buy 

Scenario 1: Call Seller 

If your Call Sell position expires OTM 
(e.g., strike 1510, stock expires at 1500) 
→ Premium becomes zero. No delivery required. 

But if your Call Sell expires ITM 
(e.g., stock expires at 1520) 
→ You must give delivery of the stock to the exchange. 

Scenario 2: Put Buyer 

If the Put Buy expires OTM 
(e.g., strike 1500, stock ends at 1550) 
→ It becomes zero. No delivery. 

If the Put expires ITM 
(e.g., stock closes at 1490) 
→ You must deliver the stock. 

The Simplest Rule of Physical Settlement 

If your option expires at zero, you have NO delivery obligation. If your option expires above zero even at ₹0.05 delivery is triggered. 

This is the cleanest way to remember the entire framework. 

Why This Matters 

This concept is extremely important because: 

• Many traders unknowingly hold ITM options till expiry.
• Even a tiny leftover premium results in a delivery obligation.
• Delivery requires significant capital or available stock.
• Failing to meet obligations can lead to penalties and forced settlement. 

Understanding expiry ensures safer decision-making. 

Closing Remarks 

This concludes our final chapter of the Technical Explainers series. 
I hope you have revised all concepts technical analysis, option Greeks, MTM, entry–exit planning and risk management. 

Review these chapters repeatedly so you can build a strong foundation and evolve as a confident derivatives trader. 

Thank you for learning with us. 

Disclaimer: Investments in securities markets are subject to market risks. Read all related documents carefully before investing.