What are derivatives expiry and settlement?

If the derivatives contract expires on the last Thursday of the month, then what happens after that? That is what is called the derivatives settlement cycle. Like inequities, the derivatives settlement cycle also has obligations some traders have to receive profits and traders who need to make good the losses. Unlike in equity settlement, F&O settlement does not entail any demat movements.

Abut derivatives expiry and settlement

To understand the futures and options settlement cycle, you need to understand two distinct types of settlement cycles. There is a final expiry settlement and there is a daily MTM settlement. Let us look at the expiry settlement first.

On the expiry of the F&O contracts, the NSCCL, which is the clearing corporation of NSE, marks all positions of a Clearing Member (CM) to the final settlement price, and the resulting profit or loss on a net basis is either debited or credited.

How is the final settlement profit or loss calculated since the contract already expired at 3.30? The final settlement profit or loss is computed as the difference between the trade price at which the transaction was initiated and the final settlement price of the relevant futures contract, based on the spot price.

Once the computation is done, the final settlement loss or profit is either debited or credited to the relevant clearing bank account of the Clearing Member (CM) on T+1 day, where T is the date of expiry. At the end of trading on the expiry date in F&O, which is the last Thursday of the month, all futures and options contracts will cease to exist, irrespective of whether the trader closed the position or did not close the position. CM transfers funds to clients.

Let us now turn briefly to the daily MTM settlement in F&O. This happens on T+0 day or the day of trade. This is also called the mark-to-market or MTM settlement. Clearing members opting for Daily MTM settlement on a T+0 basis must compute such settlement amounts daily and make funds available in their clearing account before EOD on T day. Failure to do so would be tantamount to default and entail penalties.

Even partial payment of daily MTM settlement amounts is tantamount to non-payment. In such cases, penalties would be levied. This has two implications. Firstly, the penalty for short MTM margins will be imposed at 0.07 % of the margin amount. In addition, such CMs will forfeit the benefit of scaled-down margins, applicable from the date of default to quarter-end.

What is the expiry date?

The expiry date is the date on which the F&O contract expires. It is defined as the last Thursday of each month for futures and options on equities and indices. However, If the last Thursday is a holiday, then the previous business day would be the expiry date for that contract. On the expiry date, the near month contract expires and a new contract is added at the far month-end.

This is different from the currency derivatives expiry date. Unlike in the case of equity F&O, which is last Thursday, the currency derivatives expiry date falls 2 days before the last business day of the month. On this day, the currency futures contract will expire at noon.

What is the cost of carrying?

Cost of carrying (COC) is the annualized interest percentage cost for a futures contract as compared to a spot position. If you are holding a 1 month's future on equities, there is the one-month interest cost adjusted for any dividend you would receive.

This concept of cost of carrying is very popular in commodity futures where the cost of carrying includes the interest cost for one month plus, insurance, warehousing, demurrage, and other incidental costs. In financial derivatives like equity F&O, warehousing is irrelevant and one only treats the difference as finance costs. The COC or cost of carrying is available in real-time.