What happens if an Option Contract is Not Squared Off on Expiry?

Post Date : December 20, 2024

What happens if an Option Contract is Not Squared Off on Expiry?

When an option contract reaches its expiry without being squared off, the outcome is determined by the type of option (stock or index) and its moneyness—classified as In-The-Money (ITM), Out-Of-The-Money (OTM), or At-The-Money (ATM):

• In-The-Money (ITM): The strike price of the option is advantageous for the holder, offering intrinsic value.
• Out-Of-The-Money (OTM): The strike price is unfavorable for the holder, leaving the option with no intrinsic value.
• At-The-Money (ATM): The strike price is approximately equal to the current market price of the underlying asset.

Stock Options

For stock option contracts, the handling varies based on their status at expiry:

ITM Stock Options:

• ITM contracts are physically settled, meaning the buyer or seller must deliver or take delivery of the underlying stock, depending on the position.
• It is essential to understand the physical settlement process, as margins and additional charges may apply before expiry.

OTM or ATM Stock Options:

• These contracts expire worthless since their intrinsic value is zero.
• The buyer loses the premium paid, and no further obligations remain.

Index Options

Unlike stock options, index options are cash-settled, as the underlying asset is an index (e.g., Nifty, Sensex) rather than a physical stock. The treatment of unsquared index options depends on whether they were bought or sold and their moneyness:

If the Index Options Are Bought:

ITM Index Options:

• These are automatically exercised on expiry.
• Profits or losses are settled in cash based on the difference between the strike price and the closing price of the index on the expiry day.
• Securities Transaction Tax (STT): Applicable at 0.125% of the intrinsic value for exercised contracts.
• Brokerage Charges: Charged on both sides — at purchase and settlement on expiry.

OTM or ATM Index Options:

• These contracts expire worthless.
• The buyer loses the entire premium paid as there is no intrinsic value.
• Brokerage Charges: Only applicable at the time of purchase. No charges apply on expiry.

If the Index Options Are Shorted (Sold):

ITM Index Options:

• Automatically exercised on expiry.
• Profits or losses are calculated based on the strike price, closing price, and the premium received.
• STT: Not applicable at expiry as it is charged only on the initial sell transaction.
• Brokerage Charges: Charged on both sides — when the options are sold and when they are settled on expiry.

OTM or ATM Index Options:

• These expire worthless.
• The seller retains the entire premium received at the time of the transaction.
• Brokerage Charges: Only applicable when the options were sold. No additional charges apply at expiry.

Key Considerations for Traders:

1. Monitor Open Positions Closely: Ensure you are aware of the moneyness of your contracts as expiry approaches. 
2. Physical Settlement for Stock Options: Understand the margin requirements and delivery obligations for ITM stock options. 
3. Cash Settlement for Index Options: Keep track of cash flows associated with ITM index options, especially STT and brokerage charges. 
4. Plan Your Exit: Squaring off your positions before expiry can help avoid surprises, such as additional charges or settlement complexities.

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