Explicit instruction

On expiry day, a deep in-the-money option is worth exercising almost certainly, so the exchange exercises it automatically — unless the buyer says not to. A deep out-of-the-money option is worth nothing, so it just expires.

But some options sit right on the edge, close enough to the strike that transaction costs could make exercising a loss. For these, the exchange will not guess. The buyer has to say, in so many words, "exercise this" — that is the explicit instruction.

Close to the money (CTM) options — the ATM strike plus three strikes above and three strikes below it, seven strikes in total — are exercised only on explicit instruction from the option buyer. Left silent, they simply expire, whether or not exercising would in fact have been profitable once transaction costs are counted.

This differs from the two other automatic rules: ITM options are exercised automatically unless the buyer gives a "contrary instruction" telling the exchange not to; OTM options always expire worthless, with no instruction needed either way. The seven-strike CTM band exists specifically because spot prices for options on physical goods are established through the manual, sample-based polling process, which carries its own margin of sampling error — so a wider band around the money is treated as genuinely uncertain territory that needs the buyer's own judgement.

If the Final Settlement Price falls exactly midway between two strikes, there is no single ATM strike; in that case the three strikes immediately above and three immediately below the FSP make up six CTM strikes instead of seven.

Gold options expire with the Final Settlement Price at Rs 49,900 per 10 grams, and strikes available in Rs 1,000 steps from Rs 45,000 to Rs 55,000. The Rs 50,000 strike is closest to the FSP, so it is the ATM strike; Rs 47,000–49,000 and Rs 51,000–53,000 are the three ITM and three OTM strikes on either side, making seven CTM strikes in total.

A trader long one Rs 51,000 call — a CTM, out-of-the-money strike — must decide whether exercising makes sense once brokerage and other costs are weighed. If she wants it exercised, she must submit an explicit instruction to her broker before the cut-off. If she does nothing, the position simply expires unexercised — even though, for a different trader with lower transaction costs, exercising at that strike might have been marginally worthwhile.

Chapter 4 (Commodity Options), section 4.6, sets out the ITM/CTM/ATM/OTM exercise rules for options on goods, and is one of the more heavily tested mechanical sections in the paper. Expect a direct contrast question: which category needs a contrary instruction to avoid exercise (ITM) versus which needs an explicit instruction to be exercised at all (CTM/ATM), versus which always lapses regardless (OTM).

• "Contrary instruction" and "explicit instruction" are opposite actions on opposite categories. ITM options need a contrary instruction to stop automatic exercise; CTM/ATM options need an explicit instruction to trigger exercise at all. Candidates routinely swap these two terms.
• CTM has seven strikes for Options on Goods, but the concept of CTM does not exist for Options on Futures at all — do not apply the seven-strike rule to a futures-devolving option.
• If the FSP sits exactly midway between two strikes, CTM shrinks to six strikes, not seven, because there is no single ATM strike to anchor the count.