How do Options Settle?
Options settlement is a crucial process in options trading that determines the financial outcome of an options contract. In this article, we will explore the mechanics of options settlement, the different settlement methods, and how they impact options traders.
Understanding Options Settlement
Options settle through a process known as “settlement,” which determines the financial outcome of an options contract for both the buyer and the seller. The settlement process takes place after the options contract expires or is exercised.
Options settlement can occur in two ways: physical settlement and cash settlement. The type of settlement method depends on the underlying asset and the type of option being traded. Let’s delve into each settlement method in more detail.
Physical Settlement
Physical settlement is a method of options settlement where the actual underlying asset is exchanged between the buyer and the seller. This settlement method is commonly used for options on stocks, exchange-traded funds (ETFs), or other physical assets.
In physical settlement, if the options buyer decides to exercise the contract, they will have to fulfill their obligation by buying or selling the underlying asset at the agreed-upon price, known as the strike price.
Cash Settlement
Cash settlement is another method of options settlement where the financial difference between the strike price and the market price of the underlying asset is exchanged. This settlement method is commonly used for options on indexes or futures contracts.
In cash settlement, if the options buyer decides to exercise the contract, instead of exchanging the physical asset, they will receive or pay a cash amount equal to the option’s intrinsic value.
By Astrobulls research pvt ltd