You probably must have come across the term “expiry” for medicines or food items, but some of you might be wondering, What is Expiry in Indian Stock Market? Well, here is your answer.
What is Expiry?
There are 2 types of derivatives contracts
- Futures
- Options
Both these derivative contracts are monthly contracts, meaning a derivatives position can be carried daily for a month and at the end of the month the contract expires on a pre-decided day.
The day on which derivative contracts expire is called the “Expiry Day”. On this day the contract is settled at the closing price of the underlying. After they “expire” the contracts become invalid and cannot be enforced. In Indian Stock Market, the expiry date of Index and Stock derivative contracts is on the last Thursday of every month and in case that Thursday is a holiday then it will be one day earlier on Wednesday.
Expiry of Contracts
There are 3 contracts open, for 3 consecutive months, of any stock or Index simultaneously at any given time and they expire at the end of the month on a pre-fixed date.
For the current scenario:
Near month 25th April 2021
Next month 30th May 2021
Far month 27th June 2021
are the expiry dates for the near month, next month and far month.
For currency derivative contracts, the expiry is 2 working days before the last working day so it could be any day of the last week.
For commodities derivative contracts there are different expiry dates for different commodities, as decided by the Exchange they are traded on.
All contracts are valid for a particular time period only and after the pre-decided, the last day of the contract, they are no longer valid.
So on the last day of the validity of the contract, “the expiry day”, all the open positions in a particular contract are settled at the day’s closing price, by the Exchange, automatically.
This means that in case you had a buy/sell position taken in the near month, only that position will be settled on expiry day automatically and positions are taken in the next or far month continue to remain active till the expiry day of those months.
Settlement of Contracts
Futures Contracts
After the expiry, all contracts have to be settled i.e. the profit or loss on such contracts have to be accounted for.
All FUTURES contracts can be settled in 2 ways.
Cash-settled
This means that all profit or loss has to be settled by cheque. If you have made profits you will receive a cheque or you will give a cheque if you have a loss on your traded contracts.
Physical settlement
Since July 2018, SEBI has made physical delivery compulsory as a means of settlement for almost 50 derivative contracts. They will keep adding to this list till all contracts will be settled physically and is expected to happen by October 2021.
This means that on the last day of the contract, “the expiry day” the Exchange will not automatically settle these positions but such position will result in physical delivery of the entire market lot, making the buyer of the lot pay the full value of his contract and take delivery of the stock or the seller has to give physical delivery of the entire lot for which he will receive money.
This was done mainly to curb price volatility on the expiry day but most traders or contract holders prefer to ROLL their positions to the next month.
Options Contracts
All options contracts can be settled as under:
Strike to Strike settlement
Any option contract holder, normally, holds the option till the expiry day to get the maximum benefit or profit.
If it is a CALL buy position then settlement will be calculated as Closing price – the Buying strike
If it is a PUT buy position then settlement will be Buying strike – Closing price
Premium sell-buy settlement
Many traders don’t hold their option positions till expiry and so they trade only on the premiums which may be intraday or over a few days.
After paying the premium on an option if the premium goes up then many traders sell off their positions at a profit on premium, thereby booking their profits maybe intraday or in a few and not wait for expiry day.
Physical settlement
Again as per this SEBI circular, physical delivery has been made compulsory for derivative positions in any of the 46 stocks mentioned in this list.
Rollover of contracts
Roll over of a contract simply means you square off your near month contract and take a fresh position in the next month contract.
This is done by the trader, mainly, to continue holding the derivatives contract after expiry of the near month and so the position is shifted to next month and normally is the case in a Bull market.
To explain this simply, if a trader has position in the near month he will have to settle it on expiry day but rather than leaving it for automatic expiry (in case of non-physically settled contracts) he will square off his near month position and take a fresh position in the next month before closing of trading on expiry day.
Hence, the position continues to remain open in the next month which will become the near month after the expiry of the current near month.
For e.g., April contract of a scrip will expire on 25th April (near month) so a trader will square off his position of April expiry and buy a fresh position in May (Next month) expiry. Then on the expiry of April month contract, May month contract will become the near month, June month will be next month and July, will open new, which will be the far month.
For this, the trader normally has to pay a difference which is known as Contango or “badla” charge. This charge is normally the difference between the price of a scrip in the near month and next month. A buying position attracts a badla for carrying forward of the position.
So if a trader has a futures buy position in, let’s say Reliance Ind. (1 lot at Rs.1000/-) in the near month and on the expiry day the trader wants to continue holding this position, then he will have to sell the near-month position and buy the position in the next month.
So he will sell 1 lot of Reliance Ind. on near month expiry at Rs.1010/- and buy next month contract at Rs 1015/-, thereby paying Rs.5 as a badla or carry forward charge which will work out to 0.5% for a month or 6% p.a. which is not very high and of course his cost of that 1 lot will increase by Rs.5, so now he is holding 1 lot of May expiry.
Normally the badla charges depend on the demand and supply mechanism and whenever the markets are in a bull phase the badla is high, sometimes as high as 3% per month.
A selling position or a trader with a short position will receive the badla as a credit to his account and his cost for the short position will reduce further.
Backwardation charges or Undha Badla
During a bear market when there is big sell or short positions, to carry that short position forward the seller has to pay a badla and the buyer will receive the credit in his account for his buy position.
Whenever the next month rates are lower than the near month rates it means a undha badla where there are more short sellers wanting to carry their short positions and less number of buyers to buy the next month positions and so as an incentive to the buyer the short sellers will have to pay a badla.
So for e.g. if a traders short sells 1 lot of Reliance at Rs.1020 and on expiry day the next month contract is selling at Rs.1005, he will have to buy the near month at Rs.1010 and sell the next month at Rs.1005 thereby paying Rs.5 as carry forward charge but the buyer benefits as his carry position will be sold at Rs.1010 and he can take a new buy position at Rs.1005 and he will benefit by Rs.5
Conclusion: What is Expiry in Indian Stock Market?
So this was the explanation of HOW and WHY there is an expiry on the derivatives market and about the settlement process for each. For any further information or knowledge feel free to comment below and we will be happy to answer your questions.
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