Most investors enter the stock market by investing in equities, either through an IPO or by buying shares listed on the stock exchanges. Although equities make up an ideal and simplified asset class, experienced investors diversify by investing in other asset classes, such as futures and options. Diversifying across asset classes, such as F&O, allows investors to spread the risk and earn better returns.
However, investing in the F&O market is deemed complex as it involves numerous processes, strategies, and an understanding of the factors involved. One of the most important factors that affect a futures and options contract is the expiry date of F&O.
This blog will help you understand the F&O expiry date and how it affects the overall returns you can earn from an F&O contract.
Understanding derivative contracts
Derivatives are asset classes that create contracts that derive value from an underlying asset, such as a stock, commodity, currency, or stock market index. Derivative contracts include futures and options contracts, as well as forwards and swaps.
A futures trading contract is an agreement between a buyer and seller to sell the underlying asset at a future date at a predetermined price. On the other hand, an options contract gives the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price before a certain date.
A futures contract has the compulsion that it must be exercised at the time of delivery, either through cash settlement or physical delivery of the underlying asset. On the other hand, an options contract does not require compulsory exercising, and investors can choose to ignore the contract, which expires on the expiry date.
You can invest in F&O by opening a F&O demat and trading account. These contracts are traded on stock exchanges such as NSE and BSE. However, it is important that you analyse the expiry date of F&O before investing.
Read more: What are futures
The expiry date in derivatives trading
The Securities and Exchange Board of India (SEBI) regulates every F&O contract in India. It has set the last Thursday of every month as the F&O expiry date. SEBI has standardised the expiration date of F&O to ensure investors can keep up with the expiry date of F&O contracts without any confusion or unintentional losses.
For example, if you buy an options contract on June 5th, 2024, it will expire on June 27th, 2024, the last Thursday of June. However, if the last Thursday of a month is a trading holiday (when stock markets are closed), the previous day (Wednesday) is considered the F&O expiry date.
That said, effective 1st March 2024, NSE has changed the F&O expiry date of Nifty Bank contracts from Thursday to Wednesday. For every other F&O contract, the expiry date remains the last Thursday of every month.
What happens on expiry date of F&O?
Here is what happens to a futures and options contract on the expiration date:
- Futures contract: On the expiration date, you are required to fulfil the contract. You can do it by buying another futures contract on the expiration date of the current contract. For example, if you have bought a futures contract to buy 500 shares of XYZ company, you can buy another futures contract to sell 500 shares of XYZ company. This nullifies the first contract, only requiring you to pay the price difference.
Furthermore, you can also settle the contract by paying the cash settlement required to fulfil the futures contract. - Options contract: In the case of an options contract, you have the right but not the obligation to exercise the contract. Hence, at the time of expiry, you can choose not to exercise the contract, and it will expire without any obligations. The only charge you will incur is the premium paid to the seller when buying the options contract.
Effects of expiry date on the stock price
The expiry date of F&O contracts has considerable effects on the stock prices and the entire stock market. Suppose an F&O contract has a stock or a stock market index as its underlying asset. In that case, the closure of an F&O contract results in volatility in the stock market, creating stock price fluctuations.
Furthermore, some F&O traders buy contracts from the secondary markets and sell them on the F&O market and vice versa, further creating fluctuations in the stock price.
However, stock price fluctuations are short-term in nature, and the stock market corrects itself after the expiry date of F&O.
The bottom line
The futures and options asset class is ideal for investors who want to expand and diversify their investments. However, knowing the F&O expiry date and understanding how it can affect your investments is crucial to ensuring your investments are successful. As the expiry date of F&O can create stock price fluctuations, it can also affect your equity investments.
Hence, it is important to analyse the expiry dates for every F&O contract you are considering buying and examine the underlying assets. By staying informed after the expiry dates, you can mitigate risks, capitalise on opportunities, and maintain control over your investment strategies.
