Know about Expiry In F&O | Motilal Oswal

On F&O Expiry Day

The derivatives market is a substantial portion of the investment arena in the share market today. You may consider it like this: if the markets were akin to Hollywood and the contracts in the markets were films, then the expiry dates on the contracts could be the dates when old films pass out of the cinema halls and new ones get released. The day of the month when futures and options expire, is typically the last Thursday of every month. This is the date after which contracts are invalid. 

What are expiry dates?

In the share market today, expiry dates have to do with contracts that expire in the derivatives (futures and options) markets. The dates of expiry are simply dates on which contracts expire. Every futures and options contract (derivatives contract) is based on an agreement to buy or sell any underlying security. This could be a commodity, stock, currency, etc. The contracts that investors get into or agree upon have dates of expiry before which underlying assets must be purchased or sold. 

You should know that you do not have to open a demat account for trading in futures and options contracts, like you have to do for online trading with stocks. A derivative (F & O) contract which is based on an underlying asset or security exists for a particular period and this ends on its date of expiry. On the specified date of expiry, the futures and options contract (whichever it may be) is settled with the purchaser and the seller. 

How does settlement occur?

The stock market today can be a place filled with opportunities for investors. Derivatives contracts (futures and options contracts, or F and O contracts as they are called commonly) are broadly based on trading in an underlying security. The contract exists only for a specific period and ends at a particular predetermined date. The contract, which is essentially an agreement between buyers and sellers, has to be ultimately settled by the date of a contract’s expiry. This is how the settlement of a contract takes place: 

  • A Settlement in Cash - This means that the settlement of differences between the spot price and the price of the derivative takes place via the exchange of cash. This is contrary to any settlement that may occur via the underlying security in itself. Presently, all derivatives in equity are settled with cash in the Indian markets. 
  • A Physical Delivery Settlement - Under any particular F and O contract, the physical delivery of the underlying security (as may be the case if the security is a commodity) occurs when the seller delivers the full quantity to the purchaser. The purchaser pays the price for the security when this is done. 

In the Indian share market today, the date of expiry is usually the Thursday that falls last in any month. Note that this is the last Thursday that is a working day. To fully grasp the significance of the day of expiry, you must make yourself aware of the details entailed in terms of the expiry of derivatives contracts and the settlement of these. You can then get a clearer picture of how stock prices are influenced due to the expiry date and the settlement of the applicable derivatives. 

What is the expiry in the derivatives market? 

Before going any further, you may be wondering why the word “derivative” is being used. You should be clear what a derivative is. A derivative is simply a security derived from, or dependent on, one (or more than one) underlying asset. This is usually in the form of a contract between buyers and sellers to buy or sell underlying assets.  To go ahead and explain what a derivatives expiry is, it refers to the expiry process of any derivatives contract. You may have gauged by now that each derivatives contract derives value from any underlying asset pertaining to it. This asset could take on a number of forms like a currency, commodity or a stock. As such, the underlying asset in any derivatives (F and O) contract does not have any expiry. It is the contract which is based on a particular derivative that has an expiry date. 

These days, all transactions, whether you are plainly buying stocks, subscribing to an upcoming IPO and generally partaking in online trading, are done with technology on online platforms. When you enter a futures and options contract, this can be done online too and you will encounter an expiry date of the contract in question. If a derivatives contract expires, it no longer has any validity. Therefore, every derivatives contract has to be fulfilled on the date of expiry or before the stipulated expiry date. To summarise, the future date by which contracts have to be fulfilled are the expiry dates. 

Dealing With Different Contracts

Traders are dynamic people and any trader may not be engaged with just one derivatives contract. So, it may just be a challenge to keep up with the expiry dates of various contracts that traders may have entered. For instance, a given trader may have entered contracts of derivatives each with a different underlying asset and distinct periods of expiry. Moreover, these may have different prices tied to the underlying assets. Nonetheless, to make life easy for investors and traders involved in derivatives contracts, the last working Thursday of every month has been fixed as the expiry date of futures and options contracts. In case any Thursday of a particular month turns out as a trading holiday, then the prior trading day is taken as the day of expiry for a specific month. 

Different Expiry Dates for Different Contracts 

Whether you are dealing with the stock market today or commodities, you will discover three contracts, each with distinct dates of expiry in the derivatives markets: 

  • The Far Month Contract
  • The Next Month Contract
  • The Near Month Contract

This is not a hard concept to grasp. Depending on what the date is when you presently enter into an F and O contract, the Far Month Contract will have an expiry date that corresponds to the last Thursday in the third month after the date of your entry in the contract. In a similar way, the Next Month Contract will expire on the relevant Thursday of the next month (from the present month when you enter the contract. Finally, the Near Month Contract will have an expiry date that is aligned with the last Thursday of the present month. This can best be illustrated with an example:

If you are trading with the NIFTY 50 futures, and you are presently in the month of April 2022, the following expiry dates will apply based on your contracts: 

  • Far Month Contract - The last Thursday of June 2022
  • Next Month Contract - The last Thursday of May 2022
  • Near Month Contract - The last Thursday of April 2022

What occurs on the date of expiry?

On any exchange, via online trading, two kinds of derivatives contracts can be traded by investors and traders. These are basically futures and options. Contracts such as these are entered into by traders and investors with an agreement to either purchase or sell whatever underlying asset the contract deals with by a future date at a predetermined price. This future date is representative of the date of expiry of the contract. On this particular date (or day), the traders and investors who have entered into futures contracts have an obligation to fulfil the agreement mandatorily. However, those who have entered options contracts can either select to fulfil the contract’s terms or pass it up and let it automatically expire. 

The Expiry Date - The most important day?

Traders and investors make a practice of monitoring movements of underlying assets after they have entered derivatives contracts. They also consider other factors that may influence the price of the underlying asset, such as future price movement and open interest. According to any observations that are made by traders and investors, they can take a decision on when to settle contracts, rather, square off. This is possible at any time before the expiry date. 

The settlement is the fulfilment of any derivatives contract by an expiry date that the contract stipulates. The value of the settlement of every contract is known as a “settlement value”. Such a value is commonly dependent on the underlying asset’s closing price. You should remember, even if a trader deals in the share market today, the underlying asset could be an index, a stock, currency, or a stock. The value is dependent on any of these in the cash segment as it stands on the last date of the series. 

If traders and investors fail to settle contracts voluntarily, then they automatically expire on the date of expiry. With in-the-money options and futures contracts, traders and investors must pay or must receive the value of the settlement in cash. In the case of out-of-the-money options, contracts tend to turn null and void. 

Let’s get back to the film analogy that was stated somewhere at the start, like you have sequels, if investors or traders view potential with any given contract, they are permitted to take new positions where options contracts are concerned. Alternatively, they can roll over with futures contracts in any next series of contracts. Whatever fresh positions investors and traders wish to take have to be decided on the basis of the expiry dates. 

The Settlement of Derivatives

Now that you have some familiarity with derivatives expiry in the stock market today, you must dwell on the next significant question - what exactly takes place on the expiry date? You know, in a general way, that derivatives contracts are settled on any expiry date. However, it's important to go into a little more detail about settlement aspects. 

The process through which a derivatives contract reaches settlement between a buyer and a seller is a derivatives settlement. The three ways through which any settlement takes place are: 

  1. Delivery of a Physical Nature
  2. Settlement by Cash
  3. “Squaring Off”

In the event of the physical delivery of a settlement, the underlying asset’s quantity (which is specified according to the contract) is delivered to the buyer by the seller of the derivatives contract. The buyer must pay the total price for assets mentioned in the contract. Normally, this is the case with derivatives with commodities as underlying assets. 

On the other hand, a cash settlement takes place commonly in the case of derivative contracts in which underlying assets are equity. In this case, the difference between the derivatives price and the spot price is calculated. The resultant amount is then settled through the exchange in question. In this circumstance, there is no physical delivery that occurs with any securities or assets. 

In the share market today, the term “squaring off’ is frequently used, but you should know its importance in terms of derivatives settlement. This is another way in which settlement can take place. In order for you to square off your present position, another derivatives contract must be bought by you. This has the function of cancelling out the current position you are in. For example, let us assume you have a TCS contract in futures, permitting you to buy 50 TCS shares. For you to “square off” such a position, a derivatives contract that has an opposite effect will have to be bought by you. This is because you need to be able to sell your 50 TCS shares. You are then able to “square off” both positions while only making a payment for the difference. 

How Stock Prices Are Affected

The main idea of a derivatives contract is that it derives value from an underlying asset. If the underlying asset’s price fluctuates, then the value of the derivative connected to that asset also varies. For instance, if you are entered into an equity options contract, and take a call option, you can consider the following scenarios: 

1. The equity price increases

  • The price of the share goes up.
  • This means the holder of the option can purchase the equity at a lesser price by the time of expiry. 
  • Therefore, the call option value increases. 

 

 2. The equity price drops

  • The price of the share drops.
  • This means the holder of the option can buy the equity at a higher price by the time of expiry. However, this would not yield any profit. 
  • Therefore, the call option value decreases. 

Market Influences

From your experience of online trading, you probably know that prices in the markets affect just about every activity in the market. However, in the case of derivatives trading, the equity price may affect the value of the derivative, but the derivative could affect the equity price. In certain brief trading periods, this may happen if traders in the derivatives markets have strong feelings about prices in the near market future

Consider that derivative traders may be optimistic about what the future holds. This could very well result in a rise in volumes traded in the derivatives segment, permitting holders to buy any securities. Such market behaviour influences investors who partake in spot markets. When high prices are expected at future dates, they tend to engage in high buying actions. The prices of shares then surge. This could turn the other way if traders do not show optimism about future prices. 

The Option Value and the Expiry

Generally, the longer the time that a stock has for expiry, the more time it gets to achieve its strike price. This results in more value for the stock with relation to the time. Two kinds of options exist. These are calls and puts. Calls give a right to the holder to buy stocks, without any obligation to buy stocks. This can happen if the stock achieves a certain strike price by a particular date (the expiry date). Puts essentially give holders the right to sell stocks by an expiry date at a certain price, but there is no obligation to sell on the holder’s part. Again, this can happen if the stock achieves the particular strike price. In the share market today, this is the main reason why the date of expiry is vital to any derivatives options investors and traders. The time is the crux of the value of options. After the call or put reaches expiry, the value of time gets diminished. Plainly put, when the derivative reaches expiry, the trader has no right concerning the put or the call. 

The Futures Value and the Expiry

Futures, compared to options, are different in that even futures contracts of out of the money types have a value when dates of expiry have passed. For instance, consider a contract of the commodity of oil. The contract may be representative of barrels of oil. When traders hold such contracts till the expiry, it's either due to the fact that they wish to buy or sell the oil represented by the contract. Hence, the expiry of the futures contract still has some worth. The parties in the contract are still liable to fulfil their respective ends of the contract. Those investors that do not wish to be liable in fulfilling contracts have to end up in rolled or closed positions on the last trading day or anytime before that. 

In futures trading, traders have to close the contract before the expiry date at all costs, whether they realise profits or losses. The expiry date is also called the “final trading day”. In an alternate scenario, investors may hold onto contracts, asking brokers to sell or buy underlying assets represented by the contract. Retail investors will not commonly do this, but corporations do. For instance, a producer of oil will use futures contracts for selling oil and can opt to sell their tankers. Traders in futures can also opt to “roll their positions”. This is when they close on their current trades and immediately reinstitute a new futures contract that runs further from the current expiry date. 

A Brief Recap

The expiry date of a derivatives contract, in relation to the stock market today, or while trading with any other underlying assets, is the final and last date on which the derivative stands to be valid. After the expiry date, the contract is no longer valid. According to the derivatives contract that is entered into, the date of expiry may have varied outcomes. Owners of options contracts may opt to exercise options, realising losses or profits, or let them expire without any worth. The owners of futures contracts may “roll over” a contract till a date in the future or shut their position, taking the delivery of the commodity or the asset. 

Trading Away

In the current age of investing, trading in futures and options can be a lucrative way to earn returns, if you know the ins and outs of trading with such contracts. You may have to do your homework in the share markets first, and open a demat account to get a grip of trading in general. If you start off with equity trading, there are many things you can learn, and then start in a small way with futures and options. Treading with baby steps in the share market is a good way to get a foothold into trading, and you can subscribe to any upcoming IPO too. 

The main things to keep in mind when you trade in futures and options are the different aspects of futures and options contracts. Expiry dates have a crucial role to play as they make contracts time-bound, especially with futures contracts. Along with the dates of expiry of the contracts, there is also the price of the underlying assets to consider. These are directly linked to the time factor (the expiry date), as the more time you hold assets, the more they may increase or decrease in value. However you choose to play trades in futures and options, these are contracts for seasoned traders to deal with. You can try your way with F and O, but if you are new to the share markets, then tread with care. 

 

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