Stock Options Go European from Jan 2011

3 comments Written on October 29th, 2010 by
Categories: Options

According to the NSE: (Thanks to @Prashant_Krish)

In pursuance of SEBI circular no. CIR/DNPD/6/2010 dated October 27, 2010 regarding
European Style Stock Options, circular no. 120 (Download no. 16165) dated October 28, 2010
regarding European Style Stock Options and in partial modification to consolidated circular no.
1136 (Download no. 16104) dated October 25, 2010 you are informed that all Stock Options
contracts expiring on January 27, 2011 and onwards shall have European exercise style only.

Accordingly there shall be no interim exercise available for all Stock Options contracts expiring on January 27, 2011 and onwards and all the in-the-money Stock Options contracts shall get automatically exercised on the expiry day.

All existing month Stock Options contracts expiring on November 25, 2010 and December 30,
2010 shall continue to have American exercise style.

Also read the SEBI circular.

Note: What follows is complex. Read Futures and Options: An introduction first, if you don’t know about F&O .

American options can be exercised any day – and this was creating all sorts of problems. Stocks can be moved to ensure they close at a certain point between 3 and 3:30, options then exercised (the exercise window is open till 4:30?). So the seller of the option (who knows about the exercise only at 5PM) has now no way to cross-hedge – that is, if he held a future or a different option to hedge against exercise, he has no way to take the hedge off.

Complex example: Imagine I have sold a 1100 Reliance call, and am long a Reliance Future to hedge. Reliance goes to 1140, and at 5PM I am told that my call was exercised. At 6 PM there is some adverse news on Reliance, and the next day it opens at 1090. I lost Rs. 50 right there, without even a chance to work things out.

Another problem – options are exercised against the stock, but if you hold a future to hedge, the future can quote at a discount, which ruins the hedging. If Reliance closed at 1140 but the future was at 1120, an interim exercise makes me lose 20 points. (Yes, you could hold the stock, but then how do you hedge against writing a put option?)

In America, you can deliver a stock against the exercise, so the minute you get exercised on a call, your stock is taken away, so you don’t have the above issue. In India, options are cash settled.

European options mean that you can write options and stay at peace without worrying about exercise. A huge positive: covered call strategies will be that much easier, as the stock can be used for margin now, and you don’t have to worry about an interim exercise.

Lastly the whole “dividend complication” will go away. Example: Hero Honda announced Rs. 80 dividend, and immediately the future after the ex-date shot down Rs. 80. Futures were quoting at 1,940 while the spot market showed rates of 2,020 (including the dividend). At this point, the 1900 call was quoting at Rs. 122 – why? The stock would go down to 1940 before expiry, and the Rs. 120 price has an obscene time value – yet, because stock options are American and marked to the Rs. 2,020 spot price, the price had to be at least Rs. 120. This only happened till the Ex-date, and yes, I’ve taken advantage of this many times. But I’m happy to see it go away.

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About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@gmail.com.

3 comments “Stock Options Go European from Jan 2011”

>Hi,
I agree that European options are simpler and american option are complex, but American option also bring in the realty of market (Dividends, buyback and open offers).

Now the options can be termed futures option instead of stock option

Do visit my blog to know the change in style and valuation of option after this move

http://gandhijigam.blogspot.com/

>Its good news as it will take away the manipulation in stock price for the purpose of exercising.
However I think the heavy premiums will go away and we should see tighter spreads as lot of algos will now be looking for these opportunities.

>nice information….


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