Sebi lays framework to make physical settlement of stock derivatives must

Sebi Monday issued a framework for making physical settlement of stock derivatives mandatory in a phased manner, a move that could bring much-needed balance between equity cash and derivative segments.

Stock derivatives, which are currently being cash-settled, would move to physical settlement in a prescribed manner, the Securities and Exchange Board of India (Sebi) said in a circular.

According to the regulator, stocks that are being cash-settled shall be ranked in descending order based on daily market capitalisation averaged for December 2018.

Based on the ranking arrived, the bottom 50 stocks would move to physical settlement from April 2019 expiry onwards, the next 50 stocks from the bottom would move to physical settlement from July 2019 expiry onwards, and the remaining stocks would move to physical settlement from October 2019 expiry onwards, it added.

Sebi said derivatives introduced on new stocks, meeting the enhanced eligibility criteria specified by the regulator, would also be physically settled.

Derivatives in financial markets typically refer to a forward, future, option or any other hybrid contract of pre- determined fixed duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to an index of securities.

Broadly, there are two types of derivative contracts -- futures and options. A futures contract means a legally binding agreement to buy or sell the underlying security on a future date, while options contract gives the buyer or holder of the contract the right (but not the obligation) to buy or sell the underlying asset at a predetermined price within or at the end of a specified period.

Earlier in April, the markets regulator had decided that physical settlement will be made mandatory for all stock derivatives.

In September, Sebi had issued a consultation paper asking market participants to submit their views on whether physical settlement should be done in a phased manner starting with stock options followed by stock futures.