Contrary instruction
Also written Contrary instruction to exercise · Do-not-exercise instruction
An instruction from the holder of an in-the-money option telling the exchange **not** to exercise it — the only way to stop an ITM contract being exercised automatically at expiry.
In plain language
At expiry the system does the obvious thing: every option that finished in the money is exercised, because exercising it makes money. Then it hands the holder one escape route.
A contrary instruction is that escape route. It says: I know this option is in the money, and I do not want it.
Why would anyone refuse a profit? Because exercising is not free, and because what you receive may not be what you want. Exercise costs brokerage, Commodity Transaction Tax and GST. On an Option on Futures it hands you a futures position that immediately demands margin. On an Option on Goods it hands you an obligation to pay for, or to deliver, a real commodity sitting in a real warehouse.
A thin profit is not worth any of that.
How it works
Once the Final Settlement Price is fixed on expiry day, the exchange opens a window of 15 to 30 minutes in which instructions can be given.
For Options on Futures the FSP is the daily settlement price of the underlying futures, and the window follows immediately. For Options on Goods the FSP comes from the spot polling process after the market closes — so where the underlying futures market runs to 5:00 pm the window opens around 5:30 to 6:00 pm, and where it runs to 11:30 or 11:55 pm the window opens at or after midnight. The workbook notes that for gold options at MCX the exercise window is available even up to 12:20 am.
The exchange deals only with members in this window. A client may key his choice in online, but his broker or clearing member re-uploads that instruction into the exchange system. The client does not talk to the exchange.
The same default applies to commodity index options under the March 2022 framework: all ITM contracts are exercised automatically unless a contrary instruction is given, and all OTM contracts expire worthless.
A worked example
An Option on Futures on gold. On the option expiry day the gold futures daily settlement price — which is the option's FSP — is Rs 49,900 per 10 grams. A trader holds one Rs 49,800 call, lot size 1 kilogram.
Intrinsic value = (49,900 - 49,800) x 100 units of 10 g = Rs 10,000
Rs 10,000 for doing nothing. Except that exercising devolves him into a long gold futures position at the strike of Rs 49,800, and that position is not free to hold:
| Obligation on the devolved futures | Amount |
|---|---|
| Contract value at Rs 49,900 | Rs 49,90,000 |
| Devolvement margin, charged over E-2, E-1 and E | levied on both sides |
| Initial margin plus ELM at roughly 5% | about Rs 2,49,500 |
| Tender period margin at 20% of contract value | Rs 9,98,000 |
The trader has Rs 3,00,000 in his account. He cannot fund a position that will shortly demand close to Rs 10 lakh of delivery-period margin, and he has no interest in taking a kilogram of gold out of a vault.
So he gives a contrary instruction. He forfeits the Rs 10,000 and walks away clean. That is not an error; it is the cheaper of the two outcomes.
Why NISM asks about it
Chapter 4 (Commodity Options), sections 4.4.4 and 4.5 on the exercise mechanism and the exercise window, and Chapter 2 (Commodity Indices), section 2.6, which applies the same default to index options. Expect "all ITM options are exercised automatically unless ____" and questions that pair contrary instruction with explicit instruction to see whether you can tell them apart.
Common exam traps
- Contrary instruction is for ITM options; explicit instruction is for ATM and CTM options. They are mirror images — one stops an exercise, the other starts one.
- Contrary instruction cannot revive an OTM option. Out of the money contracts lapse worthless and no instruction changes that.
- The window belongs to members, not clients. A client keys the choice in online; the broker re-uploads it to the exchange.
- The window opens after the FSP is known, which for Options on Goods means after the spot polling run — not at the close of trading.
- Devolvement is not the same as delivery. An exercised Option on Futures gives you a futures position at the strike; the delivery risk follows later.
- Assignment of exercised contracts to the short side is done in a fair and non-preferential manner — the writer has no instruction of his own to give.
Check yourself
1.Under SEBI's circular of 24 March 2022 on commodity index options, what happens to contracts on the expiry date?
- a)All ITM contracts are exercised automatically unless the buyer has given a contrary instruction; all OTM contracts expire worthless
- b)All ITM contracts expire worthless unless the buyer submits an exercise instruction
- c)All ITM and ATM contracts are exercised automatically and result in delivery of the constituent commodities
- d)The buyer must exercise every contract manually, as these are American-style options
Show the answer
Answer: (a) All ITM contracts are exercised automatically unless the buyer has given a contrary instruction; all OTM contracts expire worthless
On expiry date, all ITM contracts will get exercised automatically, unless the buyer of the option has given a "contrary instruction". All OTM contracts shall expire worthless.
Option (d) reverses the style: these are European-style options, with a minimum of three strikes available for trading — exercisable only on expiry.
Option (c) fails on settlement: index options will be cash-settled on their expiry, with the final settlement price being the index price arrived at from the volume weighted average price of the constituents between 4:00 pm and 5:00 pm on the expiry day. There is no delivery of commodities.
Two further design rules from the same circular: exchanges may introduce index options of up to 12 months expiry, and the expiry date of options shall not coincide with the roll-over of index constituents — because a roll-over is precisely the moment when the index is in transition between contracts.
Also worth carrying into the exam: because index options are cash-settled, there will not be any rolling period or delivery period margin, and all margins — SOMM, initial, concentration, additional adhoc, ELM, pre-expiry — are applicable to the seller, with initial margin applied at the level of the individual client's portfolio.
2.In India, a deep in-the-money commodity "call option on futures", on exercise, gives the option buyer:
- a)A long position in the underlying commodity futures
- b)A long position in the underlying physical commodity
- c)A short position in the underlying commodity futures
- d)A short position in the underlying physical commodity
Show the answer
Answer: (a) A long position in the underlying commodity futures
(This is a sample question from the NISM workbook.)
A call option on futures devolves into a long position in the underlying futures contract, opened at the strike price of the exercised option.
The full devolvement table:
Option position Devolves into Long call LONG futures Long put SHORT futures Short call SHORT futures Short put LONG futures Option (b) is the trap, and it names a real product — an Option on Goods on exercise does give direct delivery of the underlying commodity itself. The distinction between the two products is exactly what this question tests. A call on futures buys you a futures position; a call on goods buys you the goods.
And note the word "deep in the money" is there to confirm the option will actually be exercised: all ITM options on futures are exercised automatically unless a contrary instruction has been given.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Final Settlement PriceThe price at which a commodity derivative is finally settled at expiry — a simple average of the polled spot prices of the expiry day and the two days before it.
- MoneynessWhether exercising an option right now would give the buyer a positive, zero or negative cash flow — classifying it as in the money, at the money or out of the money.
- Close to the moneyThe band of option strikes clustered around the at-the-money strike which, in Options on Goods, lapse unless the buyer gives an explicit instruction to exercise them.
- Options on GoodsA European option whose exercise devolves directly into delivery of and payment for the physical commodity, rather than into a futures position.