What Happens on the Day of Expiry in the F&O Market?

The expiry date typically signifies the final day for the utilization of a product or service. In financial markets, especially in derivatives such as futures and options contracts, the expiry date denotes the conclusion of the contract, rendering it no longer valid thereafter. This event carries significant implications for derivative traders and the broader Indian stock market.

Understand the concept of derivative contracts

Derivative contracts are financial instruments whose value is derived from an underlying asset, index, or interest rate. They include futures, options, swaps, and forwards, allowing investors to hedge risks or speculate on price movements. These contracts typically have a predetermined expiry date and terms agreed upon by the parties involved.

Derivative contracts encompass futures and options based on stocks, commodities, currencies, and other assets. Both futures and options involve agreements to buy or sell assets at predetermined prices in the future, yet they diverge significantly beyond this basic similarity.

The Expiry Date in Derivatives Trading

In the Indian stock market, Bank Nifty expiry day falls on the last Wednesday of the expiry month. If last Wednesday is a trading holiday, the contracts expire on the previous trading day, whereas the Nifty contracts expire on the last Tuesday of the expiry period. If last Tuesday is a trading holiday, then the Nifty expiry day is the previous trading day. Finnifty contracts expire every Tuesday.  

The futures contract has a monthly expiry day: the last Thursday of each month. For instance, if you buy a futures contract on January 14, 2022, it would expire on January 27, 2022, which is the last Thursday of that month. If this last Thursday falls on a holiday when the market is closed, then the expiry date shifts to the previous day, which would be the last Wednesday of the month. This ensures clarity and consistency for traders dealing in these contracts.

Options contracts are financial instruments that give the holder the right (but not the obligation) to buy or sell an asset at a predetermined price before or on a specific expiry date. In the stock market, the weekly expiry day of options contracts typically falls on the third Friday of the expiration month. This applies to standard monthly options and also weekly options such as every Friday.

Note: The National Stock Exchange (NSE) has announced a change regarding the expiry of Nifty Bank Futures and Options (F&O) contracts, shifting from Thursday to Friday. This adjustment will come into effect starting July 14, 2023.

Under the revised guidelines, the weekly Nifty contracts with Friday expiry will be scheduled accordingly.  However, in the case of a trading holiday falling on a Friday, the Friday expiry contract  will be rescheduled to the preceding trading day. 

What is the expiry day in the stock market?

Expiry day in the stock market refers to the date when derivative contracts, such as futures and options contracts, come to the end of their trading period. It is significant because traders must either settle their positions by exercising their contracts or allow them to expire. Expiry day typically occurs on the last Thursday of each month for most derivatives traded in India, including Nifty 50 expiry day, Bank Nifty Future and Options expiry day, and the Monday Expiry Index, which is specific to certain derivatives markets.

 Let us find out what happens in the different types of derivative contracts on the expiry date in share market

Options Contracts

In options contracts, there is no obligation to fulfill the contract. If the option is not exercised by the expiry date, it simply expires. The premium paid to purchase the option is retained by the seller, and the holder of the option does not incur any additional costs beyond the initial premium. This flexibility allows investors to manage risk without being compelled to take further action if market conditions do not warrant it.

Futures Contracts

Under a futures contract, fulfillment on the expiry date involves two main methods:

Equalizing with an Opposite Contract: If you initially bought a futures contract to purchase 1000 shares of XYZ company, you can nullify this obligation by subsequently buying a futures contract to sell the same quantity of shares. This action cancels out the original contract and remains valid. However, any price differential between the initial purchase and subsequent sale must be settled. This difference arises due to fluctuations in the stock's price, which directly affect the futures contract price daily.

Cash Settlement: Alternatively, you can opt for cash settlement on the market expiry day. For example, if you hold a futures contract to purchase 1000 shares of XYZ company, you would settle the contract by paying the required amount rather than physically acquiring the shares. This method allows traders to manage their positions without the need for physical delivery of the underlying asset.

Swaps: Swaps are financial agreements or a derivative contract where two parties exchange cash flows based on different financial instruments (like interest rates or currencies). On the market expiry day, the swap contract may simply end with the final exchange of cash flows, or it may be extended or renegotiated depending on the terms agreed upon.

Forwards: Similar to futures, forwards typically involve physical delivery of the underlying asset at market expiry day. However, forwards are customized contracts traded over-the-counter (OTC), so the terms can vary widely and may involve cash settlement depending on the agreement between the parties.

Sensex Expiry Day 

As per the BSE guidelines, all monthly contracts for single stock derivatives will now expire on the second Thursday of each month.

Effect of the Expiry Date in Stock Market 

The Futures and Options (F&O) expiry date typically triggers significant volatility across the stock market. This volatility hinges on the settlement of derivative contracts, which can sway market sentiment toward bullish or bearish directions.

Furthermore, arbitrage trading plays a pivotal role during this period as F&O traders evaluate the performance of underlying assets before expiration. This practice involves exploiting price differentials between secondary markets and F&O markets to maximize profitability.

These transactions, involving buying and selling in both markets, contribute to stock price fluctuations that resonate throughout the stock market. It is significant to note that these effects are temporary, as the market tends to stabilize once the expiration date concludes.

Impact of Expiry Day on the F&O Market

• The F&O marks a critical event in the expiry date in derivatives trading, carrying substantial implications for the futures and options market.
• It triggers substantial stock price movements driven by speculative trading and the approaching contract expiry. 
• Traders must meticulously analyze these price shifts to make informed decisions. As market participants roll over their positions, liquidity dynamics undergo notable changes, necessitating adept execution strategies. 
• Expiry day also unveils diverse trading opportunities such as price reversals, arbitrage prospects, and trend continuations. 
• Understanding the intricacies of contract rollover is crucial as it can profoundly alter market dynamics, guiding traders in developing effective strategies to capitalize on market fluctuations.

Strategies for trading on Expiry Day

Traders in futures and options markets should have effective strategies to handle market volatility, especially on expiry days, to find opportunities and reduce risks.

• Iron Condors and Vertical Spreads: Traders can use these strategies where they buy or sell contracts with different expiration dates and prices. This helps in managing risks when the market fluctuates.
• Close Positions Before Expiry: Due to uncertainty on expiry day, traders should close their positions earlier to avoid potential large losses and settlement issues.
• Delta Hedging: Traders can use options to reduce the impact of price movements. Balancing delta exposure helps maintain stable trading conditions.
• Sell Cash-Secured Put Options: This strategy generates income and limits losses by selling options, providing market premiums and risk management.
• Monitor Market Dynamics: Traders should analyze market trends, news, and open interest to adjust their strategies accordingly.
• Implement Stop-Loss Orders: Using stop-loss orders helps protect capital by automatically selling positions if prices reach preset levels, thus managing risk effectively.

The Bottom Line

For futures and options traders, awareness of the expiry date for derivative contracts is crucial. This date signifies the culmination of contract settlement obligations, necessitating a clear understanding of its implications.

As a stock trader, understanding the broader impact of expiry dates on the overall market is essential. Enhanced market volatility nearing expiry can offer opportunities for short-term gains, but it also poses risks that could lead to losses. Therefore, making informed trading decisions hinges on grasping these dynamics and strategically assessing whether to capitalize on volatility or adopt a cautious approach to mitigate potential downsides.

Ultimately, mastering these concepts empowers traders to navigate expiry dates effectively, aligning their strategies with market conditions to optimize outcomes.

Disclaimer: Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Before you invest in stocks, derivatives, mutual funds, or other stock market-traded instruments, make sure to carefully read the Risk Disclosure documents.