Mastering Derivatives: Does T+1 impact F&O trading?

The settlement cycle in the spot market where underlying assets trade is now T+1. This is in line with the SEBI directive that required the NSE and the BSE to gradually shift all the stocks from T+2 to T+1, starting last February. This week, we discuss whether the change in settlement cycle in the spot market impacts derivatives trading.

Lower risk capital

Suppose you want to buy 250 shares of Reliance Industries. At the current price of ₹2,319, you need ₹5.80 lakh of trading capital not including transaction costs to execute the trade. If you instead buy one contract of February Reliance futures which obligates you to buy 250 shares of Reliance, you must deposit an initial margin of ₹1.07 lakh and hold some amount in your trading account to provide for the mark-to-market margin (MTMM). And if you want to buy the February 2320 call, you must pay 13750.

The point is this: If you buy the futures contract, you can participate in Reliance’s upside movement for one-fifth of the trading capital required to buy equivalent shares. This is possible because futures price moves closely with the underlying price and requires only initial margin and MTMM. With options, your participation is just over 50 per cent of the upside in the underlying with a small capital. Note that the upside participation through options is determined by the option delta, which captures the approximate change in the option price for a one-point change in the underlying.

The objective of trading derivatives is to participate in the price movement of the underlying, not to eventually take delivery of the shares. In this regard, the permitted lot size acts as a contract multiplier and not as an obligation in case of futures or right in case of options to buy the underlying. Therefore, the settlement cycle may not be an important factor in trading derivatives.

There is also a technical reason. Taking delivery of the underlying through futures or options increases the cost of purchasing the underlying. If your intention is to exercise a call option and buy the shares, your total cost will be the strike price plus the call option premium. The case is not different with futures. Typically, futures trade at a higher price relative to the underlying. For instance, February Reliance futures trade 12 points higher than the spot price. At expiry, the futures price converges with the spot price. You can, therefore, consider the higher price paid for futures (12 points for Reliance) as an additional cost to acquire the shares.

Taking advantage

The objective of trading derivatives is to participate in the price movement of the underlying, not to eventually take delivery of the shares

Optional reading

Sometimes, traders short put options to lower the cost of buying the underlying. This is because short put creates an obligation to buy an underlying and the premium captured from the short put reduces the cost of buying the underlying. In such cases, the revision in settlement cycle means that the settlement process must be completed a day earlier than before.

The author offers training programmes for individuals for managing their personal investments

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