SEBI allows stock exchanges to offer European style options

[The following post has been contributed by Vaibhav Kumar, who is an Associate at the law firm, Desai & Diwanji, Mumbai.]

In a significant development, SEBI by a circular dated 27th October has provided the Stock Exchanges with the flexibility of offering either European Style or American Style Stock Options. At present, it is only American style options which are allowed as per the SEBI circular of 20th June, 2001.

Simply stated, a stock option is a right but not an obligation to buy (call) or sell (put) a stock at a specified price on or before a given date in future. In an option contract, there are two parties- the buyer/holder/owner who takes a long position, and the seller/writer who takes a short position. The American Style options are those which can be exercised at any time during the subsistence of the contract, whereas, the European style options can be exercised only on the date of expiry of the option, i.e. on the agreed date.

As per the circular, after opting for a particular style, a stock exchange shall offer options contracts of the same style on all eligible stocks. It further directs the stock exchanges to put in place the systems, procedures, rules and regulations required for the introduction of European style options. Stock exchanges are to notify all the market participants, including general public at least one month in advance of implementing the switchover in the exercise style.

The interesting part of the circular is the leeway given to stock exchanges to change to another style of stock option after opting for a particular style, with the prior approval of SEBI. This is certainly helpful as it will not give rise to any kind of rigidity in the bourses.
This is seen as a progressive step taken by SEBI as it will boost the trading volume in options for the risk involved is more in American Options. In European-style options, the seller is aware about the timeline he has until the option is exercised. Further, on a separate note, as regards the European style options, there cannot be any option assignment unlike the American-style where there can be assignment prior to expiration of the option.

In furtherance of this circular, the NSE has already announced that it will offer European style stock options.

This circular is available here.