Cash Settlement vs Physical Settlement
Two methods of settling expiring derivatives contracts in India: cash settlement pays the difference between the settlement price and entry price in cash, while physical settlement requires actual delivery of the underlying shares, mandated by SEBI for all single-stock derivatives since October 2019.
Prior to October 2019, all single-stock futures and options contracts on NSE were settled in cash at expiry. This meant that at expiry, the exchange simply computed the final settlement price (based on the weighted average of the underlying stock's spot price during the last thirty minutes on expiry day), calculated the profit or loss on each open position, and transferred cash accordingly. No actual shares changed hands.
SEBI's circular of April 2018, with effect from October 2019, mandated compulsory physical delivery for all stock futures and in-the-money stock options upon expiry. The rationale was to reduce artificial price manipulation around expiry dates. Under the cash settlement model, large option writers had an incentive to push the underlying stock price toward max pain levels — the strike price at which aggregate option buyers would lose the most. Physical settlement removed this distortion by forcing actual share delivery.
Under physical settlement, if a trader held a long stock futures contract to expiry, the trader was obligated to pay the contract value and receive the underlying shares. A short futures position holder would have to deliver the shares. Critically, the shares had to be in the trader's demat account for delivery, and the full contract value had to be available in the trading account — not just the margin. This requirement caught many retail traders off guard, as they were accustomed to closing positions before expiry.
For options at expiry under physical settlement, an in-the-money call option that was not squared off before expiry resulted in the buyer receiving the shares at the strike price. An in-the-money put option resulted in the buyer having to deliver shares. Options that expired out of the money lapsed worthless with no delivery obligation.
Index futures and options — contracts on Nifty 50, Bank Nifty, and other indices — continued to be cash settled because there was no deliverable underlying basket. The physical settlement mandate applied exclusively to single-stock derivatives.