How Does Settlement Mechanism Affect the Market Size of Derivatives? Evidence From India

I examine the Indian regulator-mandated migration of exchange-traded, monthly-settled, single-stock futures and options from cash settlement to physical settlement. Physical settlement leads to statistically significant increases in the average daily trading volume of both futures and options across each expiry month, while encouraging rollover of first-month derivative positions to later-month contracts when margin requirements are tightened for physically settled derivatives. Securities that were less traded under cash settlement benefit more from physical settlement. The major finding of this paper contrasts with prior evidence from commodity derivatives, suggesting that derivatives on financial assets (including stocks) require their own body of research.