SEBI’s Consultation Paper on Converting In-The-Money (ITM) Stock Options into Futures: Summary and Key Aspects
Table of Contents
Background
SEBI issued a consultation paper proposing the automatic conversion of ITM stock option contracts into futures one day before expiry. This move aims to mitigate risks associated with sudden price movements causing Out-of-The-Money (OTM) options to become ITM near expiry, leading to unexpected physical delivery obligations.
Key Aspects of the Proposal
1. Current Settlement Process:
● Single stock derivatives are currently settled through physical delivery based on the closing Volume Weighted Average Price (VWAP).
● OTM options that turn ITM due to market volatility can create large and unexpected physical settlement obligations.
2. Proposed Changes:
● ITM options will automatically devolve into stock futures at the strike price one trading day before expiry (E-1 day).
● These devolved futures positions can be traded or closed on expiry day (E day).
● Open futures positions at market close on expiry day will be physically settled.
3. Settlement Mechanism:
● Long ITM call options → Long futures position
● Long ITM put options → Short futures position
● Short ITM call options → Short futures position
● Short ITM put options → Long futures position
4. Margin Requirements:
● Delivery margins, currently staggered from E-4 to E day, will apply from E-4 to E-1 day.
● Futures margins will apply on expiry day to devolved positions.
Data Analysis Overview
| Expiry Date | Unique Symbols (OTM previous day and ITM on expiry day) | No. of Contracts (OTM previous day and ITM on expiry day) | No. of contracts turning OTM to ITM in last 45 minutes |
| 25-Apr-24 | 137 | 294 | 3 |
| 30-May-24 | 155 | 334 | 4 |
| 27-June-24 | 126 | 253 | 17 |
| 25-July-24 | 125 | 246 | 9 |
| 29-Aug-24 | 92 | 128 | 7 |
| 26-Sep-24 | 123 | 187 | 5 |
Observation: There were quite a few contracts turning ITM in the last 45 minutes of trading across six months, highlighting potential settlement risks.
Navia’s Perspective
At Navia, we support SEBI’s proposed changes. This measure enhances market stability, reduces settlement risk, and provides operational clarity. We believe the transition from ITM options to futures simplifies the physical delivery process and safeguards market participants from unexpected obligations.
Call to Action
SEBI has invited public comments on this proposal until December 26, 2024. Stakeholders are encouraged to share feedback through SEBI’s online platform.
We’d Love to Hear from you-
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