The Securities and Exchange Board of India (SEBI) is considering a new framework for in-the-money (ITM) single stock option contracts. Under the proposal, these options would convert into futures contracts one day before expiry (E-1 day), rather than directly resulting in physical delivery.

This change is aimed at reducing risks associated with sudden price movements that can cause out-of-the-money (OTM) options to unexpectedly become ITM options close to expiry.

SEBI released a consultation paper on December 5, inviting public feedback on this proposal until December 26, 2024.

The key points of the proposal include:

• ITM single stock options will be converted into futures contracts on the day prior to expiry, known as E-1 day.
• Traders will have the option to close their futures positions on the expiry day (E day).
• Any remaining open futures positions on E day will be settled through physical delivery, as is the current practice.

Also read: SEBI proposes revised settlement rules for inactive trading accounts

This proposal seeks to address the risks when an OTM option unexpectedly moves into the ITM category due to last-minute price changes. Such volatility, especially in the final moments of trading, can lead to large, unforeseen delivery obligations, putting traders at risk of financial losses or even defaults.

Why is this needed?

The mandatory physical settlement of single stock options has posed challenges, particularly when OTM options move into the ITM category just before expiry. The risks remain when price movements at the end of the trading day unexpectedly trigger delivery requirements. The new proposal aims to reduce such risks by converting ITM options into futures contracts, which can be closed or carried over without immediate delivery obligations.