What is Derivatives Expiry?

During the last week of every month, we tend to hear the words like derivatives settlement and derivatives expiry on all the business and news channels. Why do derivatives expire and what exactly is meant by derivatives expiry? Also, how is derivatives settlement done and how does it impact your futures and options positions. Is F&O expiry the same as currency derivatives expiry? We will answer many more such questions.

Understand to derivatives expiry

All futures and options contracts have an expiry because they are contracts and all contracts have an expiry date. Equities and bonds are assets and hence they don’t have an expiry. They exist to perpetuity. But equity futures, index futures, and currency futures are all contracts, you have derivatives expiry, you also have currency derivatives expiry. Let us focus on how the settlement of this derivative is practically done.

We will look at the equity derivatives market which consists of equity futures, index futures, equity options, and index options. In all these contracts, the contract buyer agrees to buy or sell the underlying stock or index at a fixed price (which is called the exercise price) at a future date (which is the expiry date). In the future, both buyer and seller have to fulfill their obligations. However, in options, it is at the choice of the buyer.

Derivatives expiry is the date by which the contracts have to be fulfilled. If you are long on RIL futures for the month, you must close it before the expiry date, or else it will be settled automatically at the settlement price on the expiry date. In India, as per SEBI regulations, all F&O contracts can only expire on the last Thursday of every month. If the last Thursday happens to be a trading holiday, then the previous trading day will be the expiry date.

Derivatives settlement happens on the derivatives expiry date. Profits on the futures and options positions are credited and any losses have to be paid in by the clients. This entire position is called derivatives clearing and settlement and is similar to cash clearing and settlement except that there is a shares transaction and only the cash gets transacted against the outcome of the contracts.

After the futures and options contract expires on the last Thursday of the month, a new contract begins. Normally, at any point, there are the near month, mid-month, and far month contracts. Each is the subsequent months one after the other. As the derivative expiry happens, the mid-month contract becomes near month; the far month becomes mid-month and a new contract gets added as the far month contract.

What is the expiry date?

As explained, the expiry date is the last Thursday of the month when the futures and options contracts are settled. Let us say you bought RIL futures one lot at Rs.2,000 and on the last day, the futures closed at Rs.2,100. Even if you don’t do anything, the profit will be credited to your trading account. Since the lot size of RIL is 250 shares, you will earn a profit of Rs.25,000. This will reduce after considering brokerage and statutory charges.

On the other hand, if the expiry of RIL was at Rs.1900, then the loss of Rs.25,000 will be debited to your trading account. In the case of options, the buyer will exercise the option only if the price is favorable. Otherwise, he lets the option waste away and forfeits the premium paid.

What is margin money?

You may buy futures and the price may fall. Who is responsible for the loss? What if the broker demands the loss and the client refuses to pay up for the loss. To avoid such cases, the exchange insists that brokers must collect initial margins which would be SPAN plus exposure margins to cover the single-day risk. From the second, mark-to-market margins are collected daily.