NSE on Derivative trading

“Plain the role and importance of the different types of Margins imposed by the NSE in Derivatives Trading” The Trading of currency futures is subject to maintaining initial, extreme loss, and calendar spread margins and the clearing corporations of the exchanges (In the case of NSE it is NSCCL) should ensure maintenance of such margins by the participants based on the guidelines issued by SEBI from time to time. The clearing corporation acts as counterparty to all contracts traded on the exchange and is responsible for settling all trades.

They control their risks, by asking the members to pay margins and provide timely information about their financial condition. There are various types of margins that the clients/ trading members/ clearing members required to deposit: Margins on both Futures and Options contracts comprise of the following: 1) Initial Margin 2) Exposure margin In addition to these margins, in respect of options contracts the following additional margins are collected 1) Premium Margin 2) Assignment Margin Span Margin NSCCL collects initial margin up-front for all the open positions of a CM based on the argins computed by NSCCL-SPAN@.

A CM is in turn required to collect the initial margin from the TMs and his respective clients. Similarly, a TM should collect upfront margins from his clients. Initial margin requirements are based on 99% value at risk over a one day time horizon. However, in the case of futures contracts (on index or individual securities), where it may not be possible to collect mark to market settlement value, before the commencement of trading on the next day, the initial margin is computed over a two-day time horizon, applying the appropriate statistical ormula.

The methodology for computation of Value at Risk percentage is as per the recommendations of SEBI from time to time. Initial margin requirement for a member: 1 . For client positions – is netted at the level of individual client and grossed across all clients, at the Trading/ Clearing Member level, without any setoffs between clients. 2. For proprietary positions – is netted at Trading/ Clearing Member level without any setoffs between client and proprietary positions. For the purpose of SPAN Margin, various parameters are specified from time to time.

In case a trading member wishes to take additional trading positions his CM is required to provide Additional Base Capital (ABC) to NSCCL. ABC can be provided by the members in the form of Cash, Bank Guarantee, Fixed Deposit Receipts and appr securities. Additional Capital Clearing members may provide additional margin/collateral deposit (additional base capital) to NSCCL and/or may wish to retain deposits and/or such amounts which are receivable from NSCCL, over and above their minimum deposit requirements, towards initial margin and/ or other obligations.

Clearing members may submit such deposits in any one form or combination of the following forms: 1 . Cash 2. Fixed Deposit Receipts (FDRs) issued by approved banks and deposited with approved Custodians or NSCCL 3. Bank Guarantee in favour of NSCCL from approved banks in the specified format. 4. Approved securities in demat form deposited with approved Custodians. How is Initial Margin Computed? Initial margin for F&O segment is calculated on a portfolio (a collection of futures and option positions) based approach. The margin calculation is carried out using a oftware called – SPAW (Standard Portfolio Analysis of Risk).

It is a product developed by Chicago Mercantile Exchange (CME) and is extensively used by leading stock exchanges of the world. SPAN uses scenario based approach to arrive at margins. Value of futures and options positions depend on, among others, price of the security in the cash market and volatility of the security in cash market. As you would agree, both price and volatility keep changing. To put it simply, SPAW generates about 16 different scenarios by assuming different values to the price and olatility. For each of these scenarios, possible loss that the portfolio would suffer is calculated.

The initial margin required to be paid by the investor would be equal to the highest loss the portfolio would suffer in any of the scenarios considered. The margin is monitored and collected at the time of placing the buy / sell order. The SPAW margins are revised 6 times in a day – once at the beginning of the day, 4 times during market hours and finally at the end of the day. Obviously, higher the volatility, higher the margins. Exposure Margin The exposure margins for options and futures contracts on index are as follows: For Index options and Index futures contracts: 3% of the notional value of a futures contract.

In case of options it is charged only on short positions and is 3% of the notional value of open positions. For option contracts and Futures Contract on individual Securities: The higher of 5% or 1. 5 standard deviation of the notional value of gross open position in futures on individual securities and gross short open positions in options on individual securities in a particular underlying. The standard deviation of daily logarithmic returns of prices in the underlying stock in the cash market in the last six months is computed on a rolling and monthly basis at the end of each month.

For this purpose notional value means: – For a futures contract – the contract value at last traded price/ closing price. – For an options contract – the value of an equivalent number of shares as conveyed by the options contract, in the underlying market, based on the last available closing price. In case of calendar spread positions in futures contract, exposure margins are levied n one third of the value of open position of the far month futures contract. The calendar spread position is granted calendar spread treatment till the expiry of the near month contract..

How is exposure margin computed? In addition to initial / SPAW margin, exposure margin is also collected. Exposure margins in respect of index futures and index option sell positions is 3% of the notional value. For futures on individual securities and sell positions in options on individual securities, the exposure margin is higher of 5% or 1. 5 standard deviation f the LN returns of the security (in the underlying cash market) over the last 6 months period and is applied on the notional value of position.

Premium Margin In addition to Span Margin, Premium Margin is charged to members. The premium margin is the client wise premium amount payable by the buyer of the option and is levied till the completion of pay-in towards the premium settlement. Assignment Margin Assignment Margin is levied on a CM in addition to SPAN margin and Premium Margin. It is levied on assigned positions of CMS towards interim and final exercise ettlement obligations for option contracts on index and individual securities till the pay-in towards exercise settlement is complete.