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Chapter 9: Options Trade Settlement


Options contract settlements are crucial to the process of options trading, ensuring that obligations between buyers and sellers are met. Settlement can be handled in various ways, depending on the type of option and the conditions specified in the contract. Here are the primary methods of option trade settlement:

Settlement with Daily Premium

In this type of settlement, the premium amounts payable and receivable by options buyers and writers (sellers) are netted to calculate the net premium amount for each investor and their respective option contracts. If an option is exercised, the option writer is liable to pay the cash settlement amount for the settled options.

  • Example: An option buyer pays a premium of $50, and an option writer receives the same amount. If the option is exercised, the writer must pay the cash settlement to the buyer.
  • Settlement Period: This type of settlement is often denoted as T+1, where T stands for the transaction date, and +1 indicates the settlement occurs one day after the transaction date.

Settlement with Interim Exercise

Interim exercise settlements apply to options contracts where the trader can exercise an “in-the-money” option throughout the trading day. This type of settlement typically affects the close of the trading session or the option’s exercise date.

  • Example: An investor exercises an “in-the-money” call option during the trading day. The settlement occurs at the close of the trading session, reflecting the option’s intrinsic value at that time.

Final Settlement

Final settlement occurs for all open long “in-the-money” options at the close of the last trading hour on the option’s expiration date. After the final settlement, the investor receives the per-unit option exercise settlement value from the option contract writer.

  • Example: At expiration, an investor’s call option with a strike price of $100 is “in-the-money” as the underlying asset is priced at $120. The investor receives the settlement value based on the $20 difference.
  • Settlement Period: Final settlements are often denoted as T+2 or T+3, indicating that the settlement occurs two or three days after the transaction date.

Conclusion

Understanding the different methods of options trade settlement is essential for traders, to effectively manage their options portfolios. Each settlement type has specific rules and timelines, impacting how and when traders receive payments or fulfill their obligations. By being aware of these processes, traders can better navigate the options market and make informed trading decisions.

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Chapter 10: Options Greeks
Chapter 11: Options Strategies
Chapter 12: Black Scholes Model
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