New closing auction rules spark delivery risks for stock option traders | Stock Market News

Derivative traders and institutional funds could face unexpected stock delivery on monthly stock option expiries under the newly introduced closing auction session, as final settlement prices are determined only after the order-matching window closes, market experts told Mint.

Because a stock option triggers stock delivery only if it expires in the money (ITM)—at a price that beats the open market—market participants will not know whether they are obligated to take or deliver underlying shares until the auction concludes.

Options that finish out of the money (OTM)—when the market price is better than the option's price—expire worthless without triggering any delivery obligations.

The upcoming monthly stock option expires on 25 August for the NSE and 27 August for the BSE will serve as the first key test for the new mechanism. In contrast, index derivative traders will remain unaffected by these settlement uncertainties, as index contracts are settled strictly in cash.

Market experts warned that traders caught short on underlying stock during an unexpected ITM assignment—a surprise demand to fulfill the contract—may have to deliver shares at a much higher premium the next day.

“The weekly Nifty expiry on Tuesday saw positions changing from OTM to ITM because the last 15 minutes brought greater volatility. The chances of that happening in the month-end physical delivery expiry sessions are also very high,” said an executive at a leading domestic brokerage.

Under the new mechanism, continuous trading ends at 3:15 pm, after which no orders can be placed for five minutes as the market transitions to the closing auction. Between 3:20 pm and 3:30 pm, traders can place buy and sell orders within a ±3% band around a reference price based on trading activity prior to 3:15 pm. The exchange then randomly closes the order window between 3:28 pm and 3:30 pm, matching buy and sell orders to determine the official closing price—published at 3:35 pm.

This structure creates volatile price movements during the 3:15 pm to 3:30 pm auction window. Sudden price swings can abruptly push an option contract from OTM to ITM, creating a delivery liability that the trader had not anticipated or hedged against.

To illustrate how an option can swing from OTM to ITM, suppose a trader sells a call option at a ₹100 strike price when the stock is trading at ₹98 at 3:15 pm. Since the share price is below the strike, the option is OTM, and the seller expects it to expire worthless.

However, heavy buying during the 3:15-3:30 pm closing auction drives the final settlement price up to ₹102. The option finishes ITM, forcing the call seller into an unexpected loss and requiring physical delivery of the underlying shares.

Puneet Sharma, chief executive officer and fund manager at WhiteSpace Alpha, which runs long-short alternative investment funds (AIFs), said the risk arises mainly for traders with multiple positions rather than someone with a single open position.

For instance, someone who has sold both a call and a put at different strike prices could see a sharp swing in the closing auction push an OTM option into the money, instantly triggering an unexpected physical delivery obligation, Sharma added.

If physical delivery is triggered and the trader does not possess the required shares, the obligation is met through the exchange's auction mechanism that runs daily in parallel to the normal trading session between 2.30 and 3.00 PM. This auction is not to be confused with the closing auction session.

“Since shares in the auction market often trade at a premium to the prevailing market price, the trader (through the exchange) may have to buy them at an additional cost of typically around 1-2%, though the premium can be higher in illiquid stocks,” said Faizal Mohammad, vice-president for trading operations at Zerodha. There's also an additional cost of 1%, which is the auction facilitation fee, Mohammad added.

To avoid unintended physical delivery, traders can roll over their positions to the next month prior to market close. Alternatively, they can use the 3:30 pm to 3:40 pm post-close window to square off.

Because the official settlement price is published at 3:30 pm, market participants get a 10-minute buffer to see if their options finished ITM or OTM and exit accordingly. While this does not eliminate profit-and-loss impact, it guarantees they avoid physical delivery liabilities.

Ultimately, experts say the severity of these expiry risks will depend on how smoothly market participants adapt to the new closing auction sessions in the coming days.

Srushti is a markets reporter at Mint. She writes on equity markets, and her areas of coverage range from brokers and exchanges to mutual funds and the fast-evolving alternatives space, including GIFT City, from the financial capital of India. She has an experience of over three years in journalism, and has previously worked at Moneycontrol. She has an undergraduate degree in mass communication and a postgraduate diploma in business and financial journalism from Asian College of Journalism, Chennai.<br><br>Srushti prefers meeting people from the industry over making calls. Her work aims to drive impact—her story on illegal gold imports, for instance, caught the government’s attention and contributed to a policy shift. She specialises in turning complex market data into clear, engaging stories so even her grandmother could understand futures and options.<br><br>Outside of the newsroom, she enjoys spending money on jewellery and watching thriller films—especially the kind that keep her awake at night. She spends 1.5 hours a day commuting in Mumbai locals, listening to horror podcasts on her way to work. She’s also very talkative—so reach out only if you have lots of time.

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