3 Margin Types that every derivative trader must understand

If you are a derivative trader in Indian stock Markets specially an Option writer (Call and put sellers) or futures trader, you must understand various types of margin imposed by your broker. Failing to maintain adequate margin can lead to very high penalty beside ad hoc squaring-off existing positions to trim the size of your overall positions.

SPAN margin

The initial margin required for the positions is computed online and on an intraday basis, using a software called SPAN (Standard Portfolio Analysis of Risk). Sellers of options (both call and put) and holders of futures (both long and short), where the potential losses could be high, are required to have sufficient margin in their accounts. The SPAN system uses strike prices, risk-free interest rates, changes in prices of the underlying securities, changes in volatility and time-value to calculate the worst possible move in the security. For the exchanges, SPAN margin covers almost the entire risk for the day, minimizing the systemic risk due to margin pressures.

In addition to SPAN margin, a premium margin is also to be charged to traders. The premium margin is the amount payable by the buyer of the option. Besides, an assignment margin is also to be levied on assigned positions towards interim and final settlement of obligations for options.

Exposure margin

Exposure or extreme loss margin is the margin charged over and above the SPAN margin. For index options and index futures contracts, 3 per cent of the notional value of a futures contract is to be levied. In case of index options, it will be charged only on the sellers.

For options and futures contracts on individual securities, the higher of 5 per cent or 1.5 per cent of standard deviation of the notional value of gross open positions in futures and gross short open positions in options will be charged.

In case of calendar spread positions in futures contracts, exposure margins will be levied on one-third of the value of open positions of the far-month futures contract.

The calendar spread position is granted calendar spread treatment until the expiry of the near or current month contract.

Exchanges disclose the applicable margin for the contract period at the start of the new cycle. While most of the contracts (non-volatile stocks) attract 5 per cent, there are exceptions — Reliance Communications is being charged an exposure margin of 11.87 per cent and PC Jeweller 11.63 per cent for June.

Mark-to-market margin

The mark-to-market margin is collected from a trader before start of trading on the next day. Mark-to-market loss is calculated by marking each transaction in security to the closing price of the security at the end of trading. In case the security has not been traded on a particular day, the latest available closing price would be considered as the closing price.

For shortfall in SPAN and exposure margins, penalty would be levied from the trade date and for non-collection of MTM losses, from the next working day.