Page 180 - DCOM510_FINANCIAL_DERIVATIVES

Unit 11: Clearing and Settlement

money options on the expiry date, will receive the exercise settlement value per unit of the Notes
option from the investor who has been assigned the option contract.
Exercise process: The period during which an option is exercisable depends on the style of the
option. On NSE, index options are European style, i.e. options are only subject to automatic
exercise on the expiration day, if they are in-the-money. As compared to this, options on securities
are American style. In such cases, the exercise is automatic on the expiration day, and voluntary
prior to the expiration day of the option contract, provided they are in-the-money. Automatic
exercise means that all in-the-money options would be exercised by NSCCL on the expiration
day of the contract. The buyer of such options need not give an exercise notice in such cases.

Did u know? Voluntary exercise means that the buyer of an in-the-money option can direct
his TM/CM to give exercise instructions to NSCCL.
In order to ensure that an option is exercised on a particular day, the buyer must direct his TM to
exercise before the cut-off time for accepting exercise instructions for that day. Usually, the
exercise orders will be accepted by the system till the close of trading hours. Different TMs may
have different cut-off times for accepting exercise instructions from customers, which may vary
for different options. An option, which expires unexercised, becomes worthless. Some TMs may
accept standing instructions to exercise, or have procedures for the exercise of every option,
which is in-the-money at expiration.
Once an exercise instruction is given by a CM to NSCCL, it cannot ordinarily be revoked.
Exercise notices given by a buyer at anytime on a day are processed by NSCCL after the close of
trading hours on that day. All exercise notices received by NSCCL from the NEAT F&O system
are processed to determine their validity. Some basic validation checks are carried out to check
the open buy position of the exercising client/TM and if option contract is in-the-money.

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Caution Once exercised contracts are found valid, they are assigned.
Assignment process: The exercise notices are assigned in standardised market lots to short
positions in the option contract with the same series (i.e. same underlying, expiry date and
strike price) at the client level. Assignment to the short positions is done on a random basis.
NSCCL determines short positions, which are eligible to be assigned and then allocates the
exercised positions to any one or more short positions. Assignments are made at the end of the
trading day on which exercise instruction is received by NSCCL and notified to the members on
the same day. It is possible that an option seller may not receive notification from its TM that an
exercise has been assigned to him until the next day following the date of the assignment to the
CM by NSCCL.
Exercise settlement computation: In case of index option contracts, all open long positions at in-
the-money strike prices are automatically exercised on the expiration day and assigned to short
positions in option contracts with the same series on a random basis. For options on securities,
where exercise settlement may be interim or final, interim exercise for an open long in-the-
money option position can be affected on any day till the expiry of the contract. Final exercise is
automatically affected by NSCCL for all open long in-the-money positions in the expiring
month option contract, on the expiry day of the option contract.

The exercise settlement price is the closing price of the underlying (index or security) on the
exercise day (for interim exercise) or the expiry day of the relevant option contract (final
exercise).

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