Options Assignment & Physical Settlement in India: What Retail Traders Must Know

Two settlement regimes: index (cash) vs stock (physical)

India separates how derivatives settle depending on the underlying:

• Index options (Nifty, Bank Nifty, etc.) are cash-settled. If an index option finishes in-the-money (ITM) at expiry, the long is cash-credited with intrinsic value and the short is debited. There is no delivery of shares.
• Stock options (options on individual stocks) are physically settled — if exercised, shares change hands. SEBI mandated phased mandatory physical settlement for stock derivatives to reduce speculation and improve market integrity. That means an exercised call results in the buyer receiving shares and the assigned seller delivering shares (or the equivalent cash settlement when the infrastructure dictates).

Exercise style and automatic exercise at expiry

Practically in India the exchanges treat both index and stock options as exercise-at-expiry (European style) for final exercise processing: any option that is ITM at the close of trading on expiry day is automatically exercised by the clearing corporation. Exchanges then pass exercise obligations to clearing members who allocate assignments to short positions at the client level. Final exercise/assignment is processed automatically on expiry day.

Important: “Automatic exercise” protects option holders who might be away, but it also creates obligations for short sellers and buyers who lack funds/shares. Brokers often have internal cutoff times and may square off positions before expiry to prevent assignment risk — check your broker’s rules.
 

How assignment works (short positions)

When the clearing corporation exercises long positions, it randomly assigns exercised contracts to short open positions (at the clearing member / broker level) and then to client accounts. That means a trader who is short an option may be assigned even if they did not trade that option on expiry day. Assignment is not selectable — it is allocation by the clearing house. Expect the assigned short position to suddenly show a delivery obligation (for stock options) or a cash debit (for index options).

Timelines & mechanics (what happens on expiry day)

• Close of trading (expiry day): Option series close — exchanges compute closing/settlement prices.
• Automatic exercise: ITM options (by exchange rules) are flagged for exercise. Clearing/settlement instructions are prepared.
• Assignment allocation: The clearing house assigns exercised contracts to short positions at the clearing member level; brokers then map to client accounts. Allocation is typically random.
• Settlement:  
  • Index options: cash settlement (intrinsic value credited/debited to clearing accounts); typically settled T+1.
  • Stock options: physical settlement — buyer receives shares (or seller delivers), and related STT/transaction levies apply; brokers impose deadlines for bringing shares/funds and may require heavy margins for physical settlement.

Costs & taxes you must anticipate

• Premium paid/received: The original premium remains part of P&L.
• Securities Transaction Tax (STT): If an option is exercised into delivery (stock option), STT on delivery transactions applies; for exercised options STT on intrinsic value is generally levied (NSE/clearing guidance and brokers cite 0.125% on exercised option intrinsic value, while STT on delivery trades is also applicable for physical delivery). Check the latest exchange/broker circulars for rates.
• Brokerage & other levies: Exchanges/brokers charge settlement fees, stamp duty and transaction charges on the exercise/assignment settlement. Brokers may also charge special handling fees for forced physical delivery.
• Margin calls: If assigned, you must have funds or shares to fulfill the obligation — otherwise the broker will liquidate positions (often at a penalty). For physical settlement, brokers typically require full contract value or free shares by prescribed cutoffs.

Practical risks retail traders face

• Unintended assignment: Being short options into expiry can leave you unexpectedly short shares (or with a cash debit).
• Insufficient margin or shares: If you don’t have funds/shares, brokers may square off runs at unfavourable prices.
• STT & higher taxes on exercise: Letting options be exercised instead of selling to close can trigger larger STT liabilities. Brokers often point out the “STT trap” — exercise can be more expensive tax-wise than selling the option before expiry.
• Liquidity & execution problems: Near expiry some strikes are illiquid; closing positions can be costly or impossible at desired prices.
• Regulatory changes: SEBI periodically updates expiry/settlement rules (for example, proposals to convert ITM options to futures or changes in expiry days) — stay updated.

Practical checklist — avoid expiry surprises

• Know the contract type: Is your option on an index (cash-settled) or stock (physical)? Treat stock options as delivery obligations.
• Monitor ITM exposures before cutoffs: If you don’t want to be exercised/assigned, close positions well before the broker’s expiry-day cutoff (many brokers close or auto-square ITM positions).
• Keep sufficient margin/funds/shares: If you are short stock options and want to avoid forced liquidation, ensure you can deliver shares or provide funds. Check your broker’s margin requirements for physical settlement windows.
• Consider selling to close rather than letting exercise happen: Selling avoids STT on intrinsic value and avoids the logistics of physical delivery; compare net costs (premium, STT, brokerage) before expiry.
• Understand auto-exercise rules: Exchanges auto-exercise ITM options; if you must opt out (some brokers allowed “do not exercise” earlier), check whether that facility exists or has been withdrawn. Don’t assume manual opt-out is available.
• Read exchange circulars and broker notices around expiry days: Rules (margin, ELM, expiry schedule) can change; exchanges publish circulars that affect costs and operational windows.

Conclusion

Expiry day is where option strategies meet market plumbing. In India the clearing corporation automatically exercises ITM options at expiry and randomly assigns shorts — cash settlement for indices, physical delivery for stocks. That combination creates real obligations (shares to deliver, STT to pay, margins to fund) that can surprise retail traders who do not plan ahead. The safest approach: know whether your option is on an index or stock, monitor ITM exposure well before expiry, keep adequate funds or shares, and prefer to sell-to-close if you want to avoid settlement logistics and STT traps. Read your broker’s expiry-day rules and exchange circulars — small procedural details can save large headaches (and money).