What is a Do Not Exercise (DNE) facility?
This facility allows a trader to instruct their broker not to exercise their option contract and automatically square off their position. Simply put, if a trader doesn’t have sufficient funds or shares in their account to take/give physical delivery, they can use the DNE facility to prevent the risk of physical settlement.
What’s the circular all about?
The National Stock Exchange (NSE) recently announced that it had scrapped the DNE facility for individual stock option contracts. This move eliminates the auto square-off option and has them face significant losses and penalties if they are dealing in the money/close to the expiry date contracts.
Brokers have expressed concern over the decision, as traders who cannot close open positions on expiry day will no longer have the option not to exercise their contracts. Instead, they will be required to take or deliver the shares underlying the options contract as per prevailing market prices. This could result in considerable losses for traders in such a situation.
Let’s understand this with an example
Assume Mr. A is holding ‘X’ stock, and this stock finishes at ₹2001 on the day of expiry. Details of Mr. A’s trade:
- Call options with ₹2000 strike
- Lot size: 250
As per the option NSE circular, on the day of expiry, Mr. A has to take delivery. For this, Mr. A must possess ₹5 Lac (250*2000). Now, what if Mr. A doesn’t have this amount on the day of delivery?
How disruptive is this going to be for Mr. A?
Mr. A could mitigate the loss by either maintaining requisite funds or squaring off the positions before 3 pm; this would de-risk him from facing a penalty.
History Of DNE
Initially, DNE was introduced to protect retail traders from huge losses. Over time DNE as a policy has been continued and discontinued several times. The timeline below will give you a brief idea about the same.
| S. No. | Period | Event |
| 1 | FY-2017 | DNE Introduced |
| 2 | October 2021 | Discontinued |
| 3 | April 2022 | Reintroduced |
| 4 | March 2023 | Discontinued |
Why was DNE discontinued and reintroduced?
In October 2021, DNE was discontinued due to changes in October 2021. But it was bought back after the Hindalco episode. In this episode, several traders couldn’t square off their trades due to the unavailability of put option buyers. This led SEBI to review its decision, and as a result, it was reintroduced.
Impact of discontinuation of DNE facility on traders
It is essential for traders to assess their exposure and ensure that they have adequate liquidity to cover any potential losses when considering all the amendments by NSE. Ultimately, this move may be beneficial for traders in the long run as it will help them better manage their positions and reduce their risks.
NSE’s scrapping of the Do Not Exercise Facility is expected to impact options trading in India profoundly. Thus, traders must stay informed of these changes and adjust their strategies accordingly to minimize risks and maximize returns. By taking the necessary preventive measures, traders can still benefit from options trading while reducing the chance of significant losses due to NSE’s new policy.
What is the way forward after the said discontinuation?
Options trading can provide significant gains but also carries a high degree of risk. This announcement from NSE is an important reminder to traders to consider their options strategies and carefully manage their positions. One of the steps you can take is to strike off your position a little early to the expiry day, as it gives you enough time to find a counterparty. However, if you wish to take delivery, you must have the required funds in your account to avoid penalty and interest on the residue amount.
Conclusion
DNE has been a safe option for traders opting for the cash settlement of the options contracts, safeguarding the interest of options traders. The discontinuation of DNE in Mar-23, it is expected to have a negative impact on options trade volume. As a trader, all you can do is, take preventive measures like squaring off your positions early and maintaining sufficient funds to avoid penalties and losses.
