Why do options trade at lesser than theoretical value on the last day of expiry?

Today is Nifty expiry and many traders will indulge in Option trading to make some quick buck if they are on right side of trade. I have seen trader taking position in Options that trades less them their theoretical value, thinking price will correct End of day and they will make profits but in reality end up making losses Many traders every expiry do not  sell their ITM options and letting it expire(especially which are very close to strike price) or else take trades/strategies assuming that discounted price of option will correct before the end of the expiry day.

Let me explain them with few elaborative examples:

1. Nifty is trading at 5650 and today is the day of expiry. At around 2:00 PM, Nifty 5600 calls and 5700 puts are trading at around Rs 45. Ideally it should be at least 50, so why?

The 5 rs difference in price in above scenario is because of  Security Transaction Tax or STT. Exchange applies STT as discussed below.

STT on normal option trades done on the exchange is 0.017% of the selling side of the premium value.

STT on BUY option positions that get exercised is 0.125% of the entire CONTRACT VALUE. 

So point to note here is STT is applied on Contract Value in case the Option get exercised.

Options are considered exercised if you hold buy positions in options till the end of expiry(till after 3.30pm on last thursday of the month) and with them having some intrinsic value or being ITM (in the money). If you are holding Options which are having value as 0.5 than do not sell that option as you need to pay both STT and Brokerage but if Option has value more than 5 rs go ahead and Sell them before market closes else you need to pay more money from your pocket.

So lets consider 2 Example to show how will STT be calculated :

• Trader X buys  1 lot of Nifty 5700 options at Rs 100 and sell it at Rs 100, you have to pay 0.017% of the premium value on the selling side. and no STT for your Buy transaction.

So while buying 50 x Rs 100 you don’t have to pay STT, but while selling you have to pay STT of Rs 0.85 [0.017% of Rs 5000 (50 x 100)].

 

• Trader Y had bought 1 lot of Nifty 5900 options at Rs 100 and didn’t sell it but let it expire on the last day of the contract, it is considered exercised. Again while buying there is no STT, but since it is exercised on the selling side you would pay an STT of Rs 375 ( 0.125% of ( (5900+100) X 50) much higher than Rs 0.85 which you would have paid if sold on the exchange instead of exercising.

Do remember that if you are short / written options (sold first), you have already paid STT and it doesn’t matter if you buy the options on the exchange or hold them till expiry to square off, there is no STT on the buying side. 
So now Traders will be able to unravel the mystery why 5600 CE and 5700 PE are trading less than their theoretical value. So if a traders exercise the Nifty Call and Put he need to pay an higher STT in tune of 300 odd Rupee per lot which is equivalent of 6 points in Nifty Options.

To Summarize on Expiry day

1. If you have bought options and they are expiring in the money, you would rather sell it on the exchange than let it expire/exercise and having to pay much higher STT. 

2. If the options are expiring worthless (with 0 value), you don’t have to sell it to save STT because STT on options which has no value is zero. 

3. If you see options which seem to be cheap (trading lesser than theoretical value), do consider the fact that it is so because of higher STT and will not magically correct before the end of the day.l