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 at 3.5s.
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
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.