NSE to reintroduce ‘Do not exercise’ instruction for stock options

The National Stock Exchange will reintroduce the ‘Do not exercise’ instruction in stock options from April 28 after discontinuing the practice in October last year, the stock exchange said in a circular on April 11.

The system, which was introduced in 2017, was a fail-safe for options traders during the time of cash-settlement of options contracts. However, with the introduction of the physical delivery settlement, the system became redundant as the risk of paying securities transaction tax was no longer present.

However, earlier this year, market participants such as Zerodha’s Co-founder Nithin Kamath highlighted that the removal of the ‘Do not exercise’ option has created risk of huge losses for traders whose positions in the out-of-money options suddenly became in-the-money at the time of the expiry.

Under the current system, it was mandatory for traders to either square off their existing in-the-money positions before the expiry of the contract or ensure physical delivery. The situation for a put option buyer holding in-the-money contracts at the time of the expiry was especially grim as he would have to buy the shares from the auction and deliver to the put writer.

In January, the risk became real after several traders complained of humungous losses in the out-of-money put options of Hindalco Industries expiring in December, which suddenly became in-the-money on the day of the expiry due to a sudden fall in the share price in the closing hours of the session.

The catastrophic losses suffered by many retail investors who had bought Hindalco’s out-of-money put options was largely a function of lack of awareness of the new rules that were introduced in October 2021.

With the reintroduction of the ‘do not exercise’ options, traders will now be able to give explicit instruction to brokers to not exercise the option and automatically square off their out-of-money positions.