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Settlement of Option contracts

Option contracts have three types of settlements, daily premium settlement, exercise settlement, interim exercise settlement in the case of option contracts on securities and final settlement

Daily premium settlement: Buyer of an option is obligated to pay the premium towards the options purchased by him. Similarly, the seller of an option is entitled to receive the premium for the option sold by him. The premium payable amount and the premium receivable amount are netted to compute the net premium payable or receivable amount for each client for each option contract.

Exercise settlement: Although most option buyers and sellers close out their options positions by an offsetting closing transaction, an understanding of exercise can help an option buyer determine whether exercise might be more advantages than an offsetting sale of the option. There is always a possibility of the option seller being assigned and exercise. Once an exercise of an option has been assigned to an option seller, the option seller is bound to fulfill his obligation (meaning pay the cash settlement amount in the case of a cash settled option) even though he may not yet have been notified of the assignment.

Interim exercise settlement: Interim exercise settlement takes place only for option contracts on securities. An investor can exercise his in the money options at any time during trading hours, through his trading member. Interim exercise settlement is effected for such options at the close of the trading hours, on the day of exercise. Valid exercised option contracts are assigned to short positions in the option contract with the same series, on a random basis, at the client level. The CM who has exercised the option receives the exercise settlement value per unit of the option from the CM who has been assigned the option contract.

Final exercise settlement: Final exercise settlement is effected for all open long in the money strike price options existing at the close of trading hours, on the expiration day of an option contract. All such long positions are exercised and automatically assigned to short positions in option contracts with the same series, on a random basis. The investor who has long in the money options on the expiry date will receive the exercise settlement value per unit of the option from the investor who has been assigned the option contract.

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