Securities and Exchange Board of India (“SEBI”) has, vide its circular dated July 15, 2010 (“Circular”), provided the stock exchanges with the flexibility to offer physical settlement and/or cash settlement for both stock options and stock future contracts. The Circular is further to SEBI’s earlier circulars, dated June 20, 2001 and November 2, 2001 dealing with settlement of stock options and future contracts. Currently, all derivatives contracts in India are settled in cash by paying the difference in the prices of contracts when it was bought and when it is settled.
The salient features of the Circular are provided as under:
1. The stock exchanges can offer:
a) cash settlement (settlement by payment of differences) for both stock options and stock futures; or
b) physical settlement (settlement by delivery of underlying stock) for both stock options and stock futures; or
c) cash settlement for stock options and physical settlement for stock futures; or
d) physical settlement for stock options and cash settlement for stock futures.
2. The concerned stock exchanges have been provided with the flexibility to introduce physical settlement in a phased manner; however such physical settlement must be completed within six months of execution of the securities contract.
3. The mechanism for settlement of stock options or stock futures shall be decided by the concerned stock exchanges in consultation with the depositories.
4. The risk management framework in the derivative market for single stock futures, which is applicable to the cash segment, as provided under the circular dated November 2, 2001 shall be applicable in case of expiry or exercise of physically settled stock derivatives.
5. The Circular provides that cash segment and equity derivative segment shall be separately settled.
6. The stock exchange that plans to introduce physical settlement of stock derivatives is required to:
a) put in place proper systems and procedures for smooth implementation of physical settlement;
b) make necessary amendments to the relevant bye-laws, rules and regulations for implementation of physical settlement; and
c) bring the provisions of the Circular to the notice of all categories of market participants, which includes the general public, and also to circulate the same on their websites.
7. The stock exchange interested in offering physical settlement of stock derivatives is required to obtain prior approval from SEBI. In order to obtain such prior approval, the stock exchange is required to submit a detailed framework for the mode of implementation of physical settlement of stock derivatives to SEBI. The Circular allows the flexibility to a stock exchange to adopt another mode of settlement for stock derivatives from the one that has been approved by SEBI, however prior permission of SEBI shall be required for doing the same.
8. Please note that this flexibility of settling both stock options and stock futures either physically or through cash is extended only to Bombay Stock Exchange and National Stock Exchange.
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