NISM Series VIII – Part 6: Introduction to Trading Systems, Clearing & Settlement
This is Part 6 of our NISM Series VIII Equity Derivatives short notes. In this section, we cover how derivatives are traded on Indian exchanges, who the key participants are, the types of orders you can place, and how the clearing and settlement system works. These topics carry direct questions in the NISM Series 8 exam.
Quick Answer (Featured Snippet): In India, equity derivatives are traded on NSE and BSE between 9:15 AM and 3:30 PM on working days. The clearing and settlement of all F&O trades is handled by the Clearing Corporation, which acts as the legal counterparty to every trade and guarantees financial settlement.
Introduction to the Trading System Market Timing
The derivative segment operates on all working days from 9:15 AM to 3:30 PM.
Order Matching
India's F&O platforms operate on an order-driven market model. Orders are automatically matched on a price-time priority basis:
- Every order is time-stamped the moment it is received
- The system immediately checks for a matching order
- If no match is found, the order is stored in the relevant order book until a match is available
Trading Participants – Who Can Trade? Trading Member (TM)
A Trading Member is a registered member of the stock exchange. They can trade on behalf of clients or on their own account (proprietary trading). Each TM is assigned a unique Trading Member ID by the exchange. A single TM can have multiple users (dealers, branch managers, etc.).
Types of Clearing Members (CM) 1. Trading-cum-Clearing Member
A Clearing Member who is also a Trading Member. Such members can clear and settle:
- Their own proprietary trades
- Their clients' trades
- Trades of other Trading Members and Custodial Participants
2. Professional Clearing Member (PCM)
A PCM clears and settles trades of associate Trading Members and institutional clients. Crucially, a PCM is not a Trading Member — it does not trade on the exchange itself. Typically, banks and custodians become PCMs.
3. Self-Clearing Member
A Self-Clearing Member can only clear and settle its own proprietary trades and its own clients' trades. It cannot clear or settle trades of other Trading Members.
Participant
A participant is the client of the trading member — i.e., the end investor.
Corporate Hierarchy in Trading Firms
Within a trading member firm, there are three levels of users:
| Level | Role | Access |
|---|---|---|
| 1. Corporate Manager | Highest level | Full access — all branches, all dealers, all orders, exposure limit setting |
| 2. Branch Manager | Under Corporate Manager | Access to orders and trades of all dealers in their branch |
| 3. Dealer | Lowest level | Can only view their own orders and trades |
Only the Corporate Manager can set exposure limits for branches of the firm.
Order Entry – Proprietary vs Client Orders
When placing orders on the trading system, Trading Members must categorise every order:
- "Pro" identifies proprietary orders (firm's own trading)
- "Cli" identifies client orders (must include the client account number)
Types of Orders in the Derivatives Segment
| Order Type | Description |
|---|---|
| Day Order | Valid for the current trading day only; automatically cancelled at the end of the session if unexecuted |
| Immediate or Cancelled (IOC) | Executed immediately or cancelled; no partial fills waiting |
| Limit Order | Buy or sell at a specified price or better |
| Market Order | Buy or sell at the best available price in the market at that moment |
| Stop-Loss Order | Triggered when the price crosses a specified trigger price; used to limit losses on an existing position |
Price Bands in the Derivatives Segment
Unlike the cash equity segment, there are no formal price bands in the derivatives segment. However, operating ranges are maintained to prevent erroneous order entry:
- Index Futures: Operating range = 10% of base price
- Individual Stock Futures: Operating range = 10% of base price
- Index and Stock Options: A contract-specific price range is calculated daily based on the option's delta value
Orders placed beyond operating ranges reach the exchange as a price freeze and require special approval to proceed.
Corporate Actions and Adjustments for Stock Options
When a corporate action occurs (such as a bonus issue, stock split, rights issue, or dividend), the exchange adjusts the open option positions to ensure that the relative status of positions is maintained — i.e., options that were ITM remain ITM, ATM remain ATM, and OTM remain OTM.
Adjustments are made to:
- Strike Price
- Position size
- Market Lot / Multiplier
Adjustments are carried out on the last day a security trades on a 'cum' basis in the cash market, after market close. Corporate actions covered include: Bonus, Rights, Mergers/De-mergers, Amalgamations, Splits, Consolidations, Hive-offs, Warrants, and Secured Premium Notes.
Introduction to Clearing and Settlement Role of the Clearing Corporation
The Clearing Corporation (or Clearing House) is responsible for clearing and settling all trades executed in the F&O segment. It acts as the legal counterparty to every trade, guaranteeing financial settlement even if one party defaults.
The clearing and settlement process has three components:
- Clearing – Determining what each party owes
- Settlement – Actual transfer of funds and securities
- Risk Management – Collecting margins and managing exposure
Clearing Banks
Funds settlement happens through designated clearing banks. Every clearing member must maintain a separate bank account with the Clearing Corporation's designated bank for the F&O segment.
Settlement Schedule
- Trade settlement is on a T+1 working day basis
- Members with funds pay-in obligations must have clear funds in their primary clearing account by 10:30 AM on the settlement day
Types of Settlement in Futures Mark to Market (MTM) Settlement
MTM settlement is the daily adjustment of profit and loss based on closing prices. It ensures that gains are credited and losses are collected on a day-to-day basis throughout the life of the contract.
Final Settlement (Futures)
On the expiry day, after trading hours, the Clearing Corporation marks all open positions to the Final Settlement Price (the closing cash market price of the underlying). Profits and losses are settled in cash.
Types of Settlement in Options 1. Daily Premium Settlement
Option premiums are settled daily. Members with a premium payable position pay the Clearing Corporation, which passes it on to members with a premium receivable position.
2. Final Settlement (Options)
Profit or loss on options contracts (both index and individual stock) is credited or debited to the clearing member's bank account on T+1 day (one day after expiry). Open option positions cease to exist after expiry.
Custodial Participants (CP)
Institutional investors can execute trades through any trading member but have those trades cleared and settled by their own Clearing Member. Such institutions are called Custodial Participants (CP).
SPAN – Standard Portfolio Analysis of Risk
Featured Snippet: SPAN (Standard Portfolio Analysis of Risk) is a risk management and margining software designed by CME, Chicago. It is used by Indian exchanges to calculate initial margins by estimating the largest possible one-day loss a portfolio might suffer under various market scenarios.
SPAN treats futures and options uniformly while accounting for the unique risk exposures of options portfolios. Its objective is to determine the worst-case one-day loss and set initial margins at a level sufficient to cover that loss.
Types of Margins in the F&O Segment
| Margin Type | Description |
|---|---|
| Initial Margin | Based on 99% Value at Risk (VaR) over a one-day horizon; paid at time of entering the contract |
| Premium Margin | Required from option buyers until premium settlement is complete |
| Assignment Margin | Required on assigned positions of Clearing Members for final exercise settlement |
| Exposure Margin | Additional margin charged over and above the initial margin |
| Client Margin | The Clearing Corporation informs all members of their clients' margin liability |
Quick Revision – Must-Know Points
- F&O market timing: 9:15 AM to 3:30 PM on all working days
- Settlement of trades: T+1 working day basis
- Funds pay-in deadline: 10:30 AM on settlement day
- Initial margin is based on 99% VaR
- SPAN software was designed by CME, Chicago, USA
- PCM is not a trading member — it only clears and settles
- All F&O orders are matched on price-time priority
- Index futures operating range = 10% of base price
Internal Links
- Part 5 – Option Trading Strategies
- Part 7 – Legal, Regulatory Framework, Accounting & Taxation
- NISM Series 8 Online Mock Test
- How to Register for NISM Certification
This is Part 6 of the NISM Series VIII Short Notes series on PassNISM.in. Continue to Part 7 – Legal & Regulatory Environment, Accounting, Taxation & Investor Protection.