In order to attract higher volumes, the National Stock Exchange (NSE) will replace American-style stock options with European-style contracts with effect from Monday.
All stock option contracts expiring on or after January 27 will follow the European style.
Positions in European-style options can be settled only on the day of expiry, whereas American-style options can be squared off before the expiry date, too.
While options are quite popular with investors due to their limited downside, stock options have proved to be a laggard in the Indian equity markets due to a number of illiquid counters, say market players. Also, the delivery-based volumes are 15-20 per cent of the daily average in the Indian equity markets.
European-style stock options usually go well with cash-settled derivatives, the system currently followed by NSE.
“They reduce the overnight risk for uncovered sellers of stock options. But they can be termed as just an experiment before they really take off,” J R Verma, professor of finance at Indian Institute of Management, Ahmedabad, told Business Standard.
The expiry date of a stock option specifies when the contract will become void. European-style stock options are only exercisable on the expiry date, cutting the overnight risk of volatility in the underlying asset for sellers. American-style stock options are exercisable any time before the expiry date, the reason traders are afraid to take positions on NSE, as volumes show.
If NSE’s volumes rise after the shift to European-style stock options, its liquidity pool will widen. It will also be able to retain traders’ attention and will not be vulnerable to losing derivatives volume to the Bombay Stock Exchange, as anticipated after the latter launches physical settlement in derivatives.
