What is Options Settlement in India? — Physical vs Cash Settlement

Basic concepts: cash settlement vs physical settlement

Cash settlement: The option’s final value is paid in cash equal to its intrinsic value at expiry. No shares change hands. Cash settlement is common for index options because indexes are not deliverable instruments. Cash settlement simply credits or debits the net difference to clearing accounts. 

Physical settlement: On exercise or expiry, the short party must deliver the underlying shares to the long party (for calls) or buy the shares from the long (for puts). This requires actual delivery through the depository and can create delivery, auction, and settlement obligations. Physical settlement is typical for stock (single-stock) options in India after regulatory changes. 

What Indian rules say (key regulatory points)

1. Index options — cash settled: All index options in India (for example Nifty 50 or Bank Nifty) are cash-settled. At expiry, in-the-money index options generate a cash obligation equal to intrinsic value; exchanges settle these through clearing bank accounts.

2. Stock options — physical settlement (since Oct 2019): SEBI issued mandatory physical settlement for stock derivatives (stock futures and stock options), which came into force from October 2019. That means if you hold an in-the-money stock option or an open stock futures position into expiry, you must give or take delivery of shares unless you close the position earlier.

3. Automatic exercise and assignment: Exchanges and clearing corporations in India use automatic exercise: any option that is in-the-money (ITM) at the close on expiry is automatically exercised and randomly assigned to short positions unless a clearing member instructs otherwise. That makes it important to manage positions before the cut-off if you do not want to take delivery or be assigned.

4. Settlement timeline: For options that are exercised, the clearing and settlement of cash or physical obligations are handled through the clearing corporation and the clearing bank on T+1/T+2 timelines depending on the segment and the nature of pay-ins/pay-outs. Exchanges publish the exact settlement timelines and pay-in/pay-out schedules.

Practical differences — what traders should watch

1. Operational complexity
Cash-settled index options: Simple — your broker/Clearing Member (CM) shows realised profit or loss; funds are settled through the clearing bank. No delivery, no interaction with DP (depository participant).

Physically settled stock options: Complex — if exercises/assignments are not closed, shares will be debited/credited to your demat account and you must ensure funds or shares are available for pay-in and pay-out. Brokers may square-off or force delivery if margin or holdings are insufficient.

2. Margin & liquidity implications: Physically settled contracts often require higher margin as expiry approaches because of the potential obligation to deliver or receive shares. Brokers may increase intraday or overnight margins on stock F&O to protect against delivery risk. Cash-settled index products typically carry different margin dynamics tied to cash obligations rather than physical delivery logistics.

3. Taxes and charges: Tax and levy treatment can differ: for instance, Securities Transaction Tax (STT) is applicable on exercise/assignment in certain scenarios; transaction and settlement charges may vary between cash and physical settlement. Always consult updated exchange circulars and your broker’s charges schedule.

How brokers and exchanges handle expiry logistics

Automatic exercise by exception: Most platforms automatically exercise ITM options at expiry. If you don’t want exercise/assignment, you must close positions before the exchange cut-off. Brokers may close positions on behalf of clients if margin requirements are not met.

Random assignment: When multiple short positions exist, the clearing corporation allocates exercised contracts to short holders at random. This is standard practice and unavoidable — hedging or closing early is the way to control assignment risk.

Best practices for Indian traders

1. Know the contract type: Always check whether the option you trade is index (cash-settled) or stock (physical) before holding it near expiry.

2. Monitor moneyness near expiry: If a stock option is marginally ITM, automatic exercise can create a delivery obligation you may not want. Decide to close or roll well before cut-off.

3. Check margins and broker policies: Brokers can enforce higher margins or square-off positions; read their expiry and physical settlement policies.

4. Keep sufficient funds/shares: If you plan to take or give delivery, ensure your bank balance and demat holdings meet pay-in requirements to avoid penalties or auction procedures.

Conclusion

Options settlement in India follows two clear models: index options settle in cash, while stock options generally require physical delivery after regulatory changes. The automatic exercise of ITM options and the possibility of random assignment make expiry an operationally sensitive time. For traders, the differences affect margin, tax, operational steps, and risk exposure — so always check contract specifications, follow exchange circulars, and manage positions well ahead of expiry. Understanding settlement rules helps avoid surprises and keeps your options trading disciplined and predictable.