03 May, 2017

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Losing 24 Lakhs in 5 Minutes by Dabbling in Futures & Options - Do You Know How ?

Losing 24 Lakhs in 5 Minutes by Dabbling in Futures & Options

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Avinash Gupta (Name Changed), a bright-eyed youngster, learnt the perils of dabbling in futures and options the hard way.
When the markets were about to close for the day, he noticed that Nifty call options were available at a throwaway price of 5 paise per unit and that he could make a quick profit of Rs 2.75 on each.

In a flash, Avinash mopped up all the Nifty 8,600 lots that were available. He could snare 3,000 lots for which he paid a pittance of Rs. 11,250.
As the Nifty closed at 8,602.75, he laid back expecting to cash in on a hefty gain of Rs. 6.08 lakh.
Unfortunately, Avinash lost sight of a cardinal principle of law governing Nifty options.
Apparently, the law is that if a trader squares off his long position before the market closes, he is liable to pay STT of only 0.05 per cent on the premium paid when contract is sold. However, if the contract expires, the STT rate jumps to 0.125 per cent and is charged on the entire settlement value of the contract, including the value (or price) of the asset.
Because, Avinash’s Nifty options expired worthless, he became liable to pay a massive amount of Rs. 24 lakh by way of STT on his contracts.

Always square off Nifty contracts before expiry

The big takeaway from Avinash’s tragic story is that all trades, whether a put option or a call option, must be settled before the expiry of contract. Even if the trade is in a loss, the settlement is mandatory if one wants to avoid getting ruined by the levy of STT.
It appears that most brokerages have a mechanism in place to track such trades and prevent mishaps. If the trader fails to square off his position, the system automatically does it on his behalf.
However, in Avinash’s case, the system did not trigger an alert probably because he put the buy order in the last five minutes of trade.

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