The Securities and Exchange Board of India on Thursday proposed changes to reduce risks in the stock options market, particularly concerning the sudden shift of Out-of-The-Money options to In-The-Money options near expiry.
Under the new proposal, the market regulator suggests converting ITM single stock options into futures contracts one day before expiry, instead of settling them physically. This aims to eliminate unexpected delivery obligations.
Key Proposal Highlights
ITM single stock options would be converted into futures contracts one day prior to expiry, starting from E-1 day.
Traders will have the option to close their futures positions on the expiry day. Any remaining open positions will be settled through physical delivery as currently practiced.
This adjustment addresses risks that arise when OTM options unexpectedly move into the ITM category due to significant price movements on expiry day, which can lead to substantial delivery obligations.
The proposal arises from concerns regarding the risks stemming from OTM options suddenly becoming ITM due to rapid price changes near the market close. Such shifts could require traders to deliver the underlying stock unexpectedly, despite not anticipating such obligations when they entered their positions.
Why Is This Needed?
Recently, the regulator has highlighted risks linked with the mandatory physical settlement of single stock options. Measures such as introducing net settlement mechanisms and the "Do Not Exercise" facility have been implemented.
However, challenges remain when OTM options turn ITM in the final moments before expiry, leaving traders facing large unforeseen obligations. Particularly concerning are scenarios where options that begin as OTM become ITM based on the Volume Weighted Average Price during the final minutes of trading.
This volatility can leave unprepared traders exposed to the risk of having to make physical deliveries, resulting in potential defaults, financial losses, and overall market instability. SEBI is seeking public feedback on this proposal and invites comments until Dec. 26.
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