Index Options: Settlement Explained | The Options & Futures Guide

Settlement of options transactions. Settlement Styles

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    Physically settled options are those that involve the actual delivery settlement of options transactions the underlying security they are based on.

    The holder of physically settled call options would therefore buy the underlying security if they were exercised, whereas the holder of physically settled put options would sell the underlying security.

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    Physically settled options tend to be American style, and most stock options are physically settled. It isn't always immediately obviously when looking at options as they are listed whether they are physically settled or cash settled, so if this aspect is important to you it's well worth checking to be absolutely sure.

    In practice whether an option is physically settled or cash settled isn't particularly relevant that often.

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    Cash Settlement Cash settlement isn't as common as physical settlement, and it's typically used for options contracts based on securities that aren't easily transferred or delivered. For example, contracts based on indices, foreign currencies, and commodities are typically cash settled.

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    Cash settled options are usually European style, which means they are settled automatically at expiration if they are in profit. Basically, if there's any intrinsic value in contracts at the time of expiration, then that profit is paid to the holder of the contracts at that point. If the contracts are at the money or out of the money, meaning there is no intrinsic value, then they expire worthless and no money exchanges hands.

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