Two type of margins have been specified -
- Initial Margin - Based on 99% VaR and worst case loss over a specified
horizon, which depends on the time in which Mark to Market margin is collected.
- Mark to Market Margin (MTM) - collected in cash for all Futures
contracts and adjusted against the available Liquid Networth for option positions.
In the case of Futures Contracts MTM may be considered as Mark to Market Settlement.
Dr. L.C Gupta Committee had recommended that the level of initial margin required
on a position should be related to the risk of loss on the position. The concept
of value-at-risk should be used in calculating required level of initial margins.
The initial margins should be large enough to cover the one day loss that can be
encountered on the position on 99% of the days. The recommendations of the Dr. L.C
Gupta Committee have been a guiding principle for SEBI in prescribing the margin
computation & collection methodology to the Exchanges. With the introduction of
various derivative products in the Indian securities Markets, the margin computation
methodology, especially for initial margin, has been modified to address the specific
risk characteristics of the product. The margining methodology specified is consistent
with the margining system used in developed financial & commodity derivative markets
worldwide. The exchanges were given the freedom to either develop their own margin
computation system or adapt the systems available internationally to the requirements
of SEBI. A portfolio based margining approach which takes an integrated view of
the risk involved in the portfolio of each individual client comprising of his positions
in all Derivative Contracts i.e. Index Futures, Index Option, Stock Options and
Single Stock Futures, has been prescribed. The initial margin requirements are required
to be based on the worst case loss of a portfolio of an individual client to cover
99% VaR over a specified time horizon.
- The Initial Margin is Higher of (Worst Scenario Loss +Calendar Spread
Charges) Or Short Option Minimum Charge
The worst scenario loss are required to be computed for a portfolio of a client
and is calculated by valuing the portfolio under 16 scenarios of probable changes
in the value and the volatility of the Index/ Individual Stocks. The options and
futures positions in a client's portfolio are required to be valued by predicting
the price and the volatility of the underlying over a specified horizon so that
99% of times the price and volatility so predicted does not exceed the maximum and
minimum price or volatility scenario. In this manner initial margin of 99% VaR is
achieved. The specified horizon is dependent on the time of collection of mark to
market margin by the exchange. The probable change in the price of the underlying
over the specified horizon i.e. 'price scan range', in the case of Index futures
and Index option contracts are based on three standard deviation (3s ) where 's
' is the volatility estimate of the Index. The volatility estimate 's ', is computed
as per the Exponentially Weighted Moving Average methodology. This methodology has
been prescribed by SEBI. In case of option and futures on individual stocks the
price scan range is based on three and a half standard deviation (3.5 s) where 's'
is the daily volatility estimate of individual stock. If the mean value (taking
order book snapshots for past six months) of the impact cost, for an order size
of Rs. 0.5 million, exceeds 1%, the price scan range would be scaled up by square
root three times to cover the close out risk. This means that stocks with impact
cost greater than 1% would now have a price scan range of - Sqrt (3) * 3.5s or approx.
6.06s. For stocks with impact cost of 1% or less, the price scan range would remain
For Index Futures and Stock futures it is specified that a minimum margin of 5%
and 7.5% would be charged. This means if for stock futures the 3.5 s value falls
below 7.5% then a minimum of 7.5% should be charged. This could be achieved by adjusting
the price scan range.
The probable change in the volatility of the underlying i.e. 'volatility scan range'
is fixed at 4% for Index options and is fixed at 10% for options on Individual stocks.
The volatility scan range is applicable only for option products.
Calendar spreads are offsetting positions in two contracts in the same underlying
across different expiry. In a portfolio based margining approach all calendar-spread
positions automatically get a margin offset. However, risk arising due to difference
in cost of carry or the 'basis risk' needs to be addressed. It is therefore specified
that a calendar spread charge would be added to the worst scenario loss for arriving
at the initial margin. For computing calendar spread charge, the system first identifies
spread positions and then the spread charge which is 0.5% per month on the far leg
of the spread with a minimum of 1% and maximum of 3%. Further, in the last three
days of the expiry of the near leg of spread, both the legs of the calendar spread
would be treated as separate individual positions. In a portfolio of futures and
options, the non-linear nature of options make short option positions most risky.
Especially, short deep out of the money options, which are highly susceptible to,
changes in prices of the underlying. Therefore a short option minimum charge has
been specified. The short option minimum charge is 3% and 7.5 % of the notional
value of all short Index option and stock option contracts respectively. The short
option minimum charge is the initial margin if the sum of the worst -scenario loss
and calendar spread charge is lower than the short option minimum charge. To calculate
volatility estimates the exchange are required to uses the methodology specified
in the Prof J.R Varma Committee Report on Risk Containment Measures for Index Futures.
Further, to calculate the option value the exchanges can use standard option pricing
models - Black-Scholes, Binomial, Merton, Adesi-Whaley.
The initial margin is required to be computed on a real time basis and has two components:-
The first is creation of risk arrays taking prices at discreet times taking latest
prices and volatility estimates at the discreet times, which have been specified.
The second is the application of the risk arrays on the actual portfolio positions
to compute the portfolio values and the initial margin on a real time basis.
The initial margin so computed is deducted from the available Liquid Networth on
a real time basis. At the end of the day NSE sends a client wise file to all the
brokers and this margin is debited to clients. Next day the broker is supposed to
report the collection of margin. If the margin is short, a penalty is levied and
the outstanding position is liable to be squared up at the cost of the investor.