What Happens on the Day of Expiry in the F&O Market? Process and Settlement

Expiry day in the Futures and Options (F&O) market is a pivotal moment for traders. It marks the end of a derivatives contract's validity and leads to either cash or physical settlement. As positions are squared off or carried forward, the day is often marked by heightened volatility, margin adjustments, and significant market activity. Understanding what happens on expiry day is crucial for traders to manage risks and ensure compliance with settlement obligations.

Derivative contracts are financial agreements whose value is derived from an underlying asset, such as stocks, indices, commodities, or currencies. They allow participants to speculate on price movements or hedge against risks without owning the actual asset. These contracts are standardized and traded on exchanges, with each contract having a fixed expiry date. On expiry, positions are settled either through cash or by delivering the underlying asset, depending on the type of contract.

Expiry refers to the final date on which a futures or options contract is valid. After this date, the contract ceases to exist. In India, the monthly expiry typically occurs on the last Thursday of every month unless it's a holiday, in which case it shifts to the previous working day.

Weekly options on indices and stocks may have different expiry days depending on the exchange. Expiry plays a vital role in derivatives trading because it affects pricing, liquidity, and the rollover of positions into the next contract cycle.

Several steps take place on expiry day, from closing open positions to margin adjustments and settlements. Here’s a look at the core processes:

Futures Contracts

Futures contracts are legally binding agreements to buy or sell an asset at a predetermined price on a specific date.

• Mandatory settlement: Futures must be settled on expiry. Traders either close positions or go through settlement.
  

• Cash settlement: Most index and stock futures in India are cash-settled, based on the closing price on expiry day.
  

• Physical delivery: In the case of stock futures, if not squared off, physical delivery is mandated. The buyer receives the shares and the seller delivers them.

Options Contracts

Options give the holder the right, but not the obligation, to buy or sell an asset at a predetermined price.

• In-the-money (ITM) options: These are either auto-exercised or manually squared off. If exercised, the holder is obligated to take or deliver the underlying asset.
  

• Out-of-the-money (OTM) options: These expire worthless, resulting in the loss of the premium paid.
  

• Settlement type: Index options are cash-settled, while stock options usually require physical delivery if exercised.

Margins play a crucial role in protecting both the trader and the broker from market risk. On expiry day, margin requirements typically rise, especially for positions nearing physical settlement.

• Final margin: 100% margin may be required for stock options that go into delivery.
  

• Increased exposure margin: Brokers may demand higher margins for positions that are likely to be exercised or delivered.
  

• Risk of margin shortfall: Traders must ensure sufficient funds are available to avoid penalties or forced square-offs.

On expiry day, the type of contract and the underlying asset determine whether the contract is settled in cash or through delivery.

• Cash settlement: Final gains or losses are calculated based on the difference between the strike price and the closing market price. The resulting amount is credited or debited.
  

• Physical delivery: The buyer pays the full contract value and receives the underlying shares. The seller delivers the shares to the clearing house. This usually applies to stock futures and options.

Expiry day requires strategic decisions to avoid unwanted settlements and manage exposure. Common actions include:

• Squaring off positions: Closing trades before expiry to avoid physical delivery or high margins.
  

• Rolling over positions: Carrying forward a similar position into the next contract cycle by closing the current and opening a new trade.
  

• Monitoring volatility: Traders closely watch price action, as expiry often brings sharp moves in stocks and indices.

Expiry day can significantly affect market behaviour. Due to the closing of open positions, rebalancing of portfolios, and last-minute trades, market volatility typically increases.

• High volumes: Expiry day often records one of the highest trading volumes of the month.
  

• Increased volatility: Sharp intraday swings are common, especially in stocks with heavy derivative activity.
  

• Index movement: Large institutional trades may influence index levels, especially during the closing session.

To prevent market manipulation and excessive volatility, regulators and exchanges impose certain rules:

• Position limits: Restrictions on how many contracts a trader or institution can hold
  

• Margin monitoring: Brokers and exchanges monitor margin levels closely
  

• Surveillance systems: Advanced systems track unusual trading activity to prevent mispricing and manipulation

Expiry day is one of the most crucial events in the F&O calendar. Traders must be aware of settlement rules, margin requirements, and the potential for volatility. Whether opting for cash settlement or physical delivery, managing expiry efficiently helps avoid penalties and ensures smooth trading operations.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.