Physical Settlement

This applies to stock options and futures, not index options. NIFTY, BANKNIFTY and FINNIFTY are cash-settled, since there's no physical NIFTY to deliver. It matters most to anyone who holds a stock option ITM into expiry without closing it: the exchange will settle it into a real delivery position (and the margin obligation that comes with one), not a simple profit or loss credited to the account.

The rule exists specifically to curb speculative cash-settled positions taken purely to bet on a stock's price with no intention of ever owning it. It forces delivery risk back into single-stock F&O rather than letting it behave like a pure cash derivative the way index options do.

Example: a trader holding one lot of a stock call that finishes 5% ITM, if left open into settlement, ends up owning the underlying shares at the strike price rather than receiving a cash credit, along with whatever fresh delivery margin that new equity position requires.