Market regulator Securities and Exchange Board of India (SEBI) is considering reintroduction of Do Not Exercise (DNE) option for option traders. SEBI’s Risk Management and Review Committee (RMRC) headed by Prof JR Verma met on last Thursday and discussed about the issue with the stakeholders. 

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As per the sources privy to this development, “RMRC considered the issue and favoured the reintroduction of the DNE. To review the regulation a subgroup has been formed with the mandate to suggest DNE option after studying the international markets best practices. The sub-group will suggest if DNE be allowed up to 3 strike price or more”. The source further added that “Once sub- group submits its report, RMRC will finalise the regulations and will be communicated to exchanges and clearing corporations.” The revised regulations may be out within 1-2 months.

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Brokers and market participants have been demanding to the regulator to re-introduce DNE option in Close to the Money (CTM) Option contracts. After removal of Do Not Exercise, it became obligatory for all the options holders to compulsorily take or give delivery of their options even if there are slightly in the money. Thus, the holder of the put option, which is slightly in the money would be forced to give the delivery of the underlying share, while the holder of the call option, which is slightly in the money would be forced to cough up the entire purchase consideration and compulsorily take delivery.

DNE was removed for two conceptual reasons, one was to give a level playing field for option writers who could be left with unplanned overnight exposure when the option holder choose to not exercise the option, and secondly the fact that the DNE was introduced to resolve the anomaly of excessive STT in the era where all the derivatives contracts were cash settled. Operationally, the extra processing due to DNE used to delay the Clearing Corporations process leading to complains from market participants.

NSE Clearing Limited had issued a circular on September 29, 2021, alerting its members that Do Not Exercise option will not be available from October 14, 2021, but many traders were not updated or aware of the new circular and assumed that DNE is available to them as was earlier. The new rules mandated that from November expiry, if spot price of a share closes below strike price, then trader holding put option of stock will have to either sell his position before expiry or arrange shares from auction. 

In December expiry contract, many traders who could not sell their position in Hindalco Put, suffered huge losses, due to non-availability of DNE. Traders, earlier had the maximum risk of losing only their premium money, were forced to buy the shares in the auction and settle the trade. The concerns post Hindalco episode was discussed in the Risk Management and Review Committee, stake holders pointed to the huge risk for brokers and system in case traders default is high.

In layman language Option is a contract which gives trader the right, but not the obligation to buy or sell a share at a particular date on a specified price. In Call option, the trader gets the right but not the obligation to buy stock at a specified date and price. Buyer of a Call Option profits, when the price of stock goes up and loses when stock price goes down. Similarly, the Put Option gives the right but not the obligation to sell a particular stock at a specified date and price. The pre-decided price at which the buyer of the Put option can sell the underlying security is termed as strike price. To buy the Option, there is a price to be paid which is called as premium. Premium is the income received by the seller of an option contract.