History Of F&O Margin Requirements In India

Table of Contents

The broker collects margins when investors purchase or sell a futures contract. Before initiating a trade, margins must typically be deposited into the trading account. F&O Margin must be paid regardless of whether a futures contract is bought or sold. Futures trading margins are intended to cover the risk of adverse price movements. Since markets are volatile, margins are collected to cover the risk of market volatility

National Stock Exchange (NSE) Clearing has developed a comprehensive risk mitigation mechanism for the Futures & Options segment. The online position monitoring and the margining system are the most vital components of a risk containment mechanism for NSE Clearing. On an intraday basis, the actual margining and position monitoring are done online. For F&O margin, NSE Clearing uses the SPAN (Standard Portfolio Analysis of Risk) system, which is a portfolio-based system.

utures

Initial Margin

Span Margin

NSE Clearing collects the initial margin in advance for all open positions of a CM ( Clearing Member) based on margins computed by NSE Clearing-SPAN®. A CM is then responsible for collecting the initial margin from the TMs (Trading Members) and their respective clients. Likewise, a TM must collect margins from his clients in advance.

Initial margin needs are determined by 99% of the value at risk over a one-day time horizon. The initial margin is calculated over a two-day time horizon, using the appropriate statistical formula, in the case of futures contracts (on an index or individual securities), where it may not be possible to collect mark-to-market settlement value before the start of trading on the following day. The methodology for calculating the value at risk percentage is in accordance with the recommendations of SEBI.

The initial margin requirement for a member is:

- For client positions – is netted at the client level and gross across all clients at the Trading/ Clearing Member level, with no offsets between clients.

- For proprietary positions, nets are calculated at the Trading/Clearing Member level without any offsets between client and proprietary positions.

Various parameters are periodically specified for the purpose of SPAN Margin.

Additional Base Capital (ABC) must be provided to NSE Clearing in the event that a trading member wishes to take on additional trading positions. The members may provide ABC in the form of cash, bank guarantees, fixed deposit receipts, or approved securities.

Additional Base Capital

In addition to their minimum deposit requirements, clearing members have the option to contribute more F&O margin/collateral deposits (additional base capital) to NSE Clearing or retain deposits and/or other amounts due to NSE Clearing in order to pay initial margin and/or other obligations.

These deposits may be made by clearing members in any one or combination of the following formats:

- Cash

- Fixed Deposit Receipts (FDRs) issued by authorised banks and deposited with authorised custodians or the NSE Clearing

- Bank Guarantee in favour of NSE Clearing from an approved bank in the format specified.

- Approved securities in the Demat form are deposited with approved custodians.

Premium Margin

Members are also charged Premium Margin in addition to Span Margin. The premium margin represents the client-specific premium amount payable by the option purchaser until the completion of pay-in towards premium settlement.

Assignment Margin

In addition to SPAN margin and Premium Margin, a CM is charged Assignment Margin. Up until the pay-in towards exercise, settlement is finished, it is assessed on the assigned positions of CMs for interim and final exercise settlement obligations for option contracts on index and individual securities.

The Assignment Margin represents the net exercise settlement value payable by a Clearing Member toward interim and final exercise settlement and is deducted from the Clearing Member’s margin-eligible deposits.

Effective deposits

All collateral deposits made by CMs are divided into cash and non-cash portions.

The cash component of additional base capital includes cash, bank guarantees, fixed deposit receipts, Treasury bills, and dated government securities. Non-cash component refers to all other forms of collateral deposits, such as deposits of Demat securities that have been approved.

At least half of the effective deposits should be in cash.

Liquid Networth

Liquid net worth is determined by subtracting the initial margin payable at any given time from the effective deposits.

The minimum liquid net worth that CMs must maintain at all times is Rs. 50 lakhs (referred to as the Minimum Liquid Net Worth).

For exercise settlement pay-in, the assignment margin is released to the CMs.

Initial Margin requirement = Total SPAN Margin Requirement + Buy Premium + Assignment Margin

Exposure Margin

The following are the exposure margins for index options and futures contracts:

With respect to index options and index futures: 3% of a futures contract’s notional value In the case of options, this fee is only applicable to short positions and is equal to 3% of the notional value of open positions.

For individual securities’ option contracts and futures contracts: The higher of 5% or 1.5 standard deviations of the notional value of gross open positions in futures on specific securities and gross short open positions in options on specific securities for a specific underlying. On a rolling and monthly basis, the standard deviation of daily logarithmic returns of prices in the underlying stock on the cash market over the past six months is calculated at the end of each month.

For this purpose, notional value means:

- For a futures contract, the contract value is at the closing price/last traded price.

- For an options contract, the value of an equivalent number of shares as conveyed by the options contract is based on the most recent closing price for the underlying market.

In the case of calendar spread positions in futures contracts, exposure margins are assessed on one-third of the value of an open position in a futures contract for a distant month. The calendar spread position is treated as a calendar spread until the near-month contract expires. The benefit of calendar spread in exposure margin is not applicable to option contracts because exposure is only applicable to short positions. No exposure margin is charged for long positions, so no offset can be provided.

Clearing Member

A Clearing Member (CM) of NSE Clearing is accountable for the clearing and settling of all transactions executed by Trading Members (TM) on the NSE, who clear and settle such transactions through them. Primarily, the CM is responsible for the following duties:

Clearing: The computation of all TM obligations, i.e., the determination of positions to settle.

Settlement: Actual settlement. Currently, only fund settlement is permitted for index and stock futures and options contracts.

Risk Management: Establishing position limits based on initial deposits/F&O margins for each TM and continuously monitoring positions.

Types of Clearing Members

A few of them are:

Trading Member Clearing Member (TM-CM)

A Clearing Member who also holds TM status. These CMs may clear and settle their own proprietary trades, trade with their clients, and trade with other TMs and custodial participants.

Professional Clearing Member (PCM)

A CM who is not a TM Typically, banks or custodians can become PCMs and clear and settle for both TMs and custodial participants.

Self-Clearing Members (SCM)

A clearing member who is also a TM. Such CMs are only permitted to clear and settle their own proprietary trades and those of their clients. They are not permitted to clear and settle trades with other TMs.

History Of F&O Margin Requirements

The risk associated with purchasing options is limited to the premium paid. When trading futures or short options, however, the risk is technically unlimited. Customers are charged margins to reduce the risk of counterparty default and ensure that these defaults do not pose systemic risks to the entire market.

When SEBI first introduced F&O, it established a framework for the collection of margins by market participants trading these contracts. The initial margin was the initial deposit required to enter into contracts with unlimited risks, such as futures and short options. This initial margin is the sum of SPAN and exposure margins.

SPAN (Standard Portfolio Analysis of Risk) is a widely used system developed by CME (Chicago Mercantile Exchange) to calculate risk and margins for F&O portfolios and adopted by numerous exchanges around the world. When it was introduced in 2000, the SPAN margin was intended to cover the worst possible one-day contract movement (called MPOR, or minimum Margin Period of Risk). Using the Price Scan Range (PSR) of the underlying index or stock, this worst-case scenario is calculated. The PSR is computed using the underlying’s daily volatility. The broker collects SPAN and exposure margin in advance to enable users to take a position in the futures and options markets. The margin protects against the possibility of a negative price movement.

SPAN, which stands for Standard Portfolio Analysis of Risk, is the minimum margin requirement calculated based on the risk and volatility of the underlying. Its name derives from the software used to assess it. In addition to the SPAN margin, the broker would collect an exposure margin, an additional cushion to protect the broker’s liability against wild price fluctuations. Total margin consists of SPAN plus exposure margin. Exposure margins are added to SPAN margins to cover risks that SPAN margins may not cover. This was set at 3% of the contract value for index F&O and 5% (or 1.5 standard deviation, whichever is greater) for stock F&O when F&O was introduced in India.

Aug 2011: Introduction of penalties for failure to collect SPAN

Although SEBI mandated that the broker provide margins to the clearing corporation on behalf of their customers for all F&O positions, it did not mandate that the broker collect these margins from the customer in the first place. In the 2000s, brokers competed by offering trading with lower margins than SPAN+Exposure required. This was the era of percentage brokerage, in which a client trading with more capital resulted in increased revenue for the broker, which compensated for any funding expenses. During the volatility of 2008, this system of excessive leverage harmed the industry, with many brokers nearly going bankrupt. India’s capital market ecosystem was extremely fortunate to have escaped this intense volatility unscathed.

In 2011, SEBI introduced the concept of daily reporting of customer margins and short margin penalties to mitigate this risk. If the customer had not deposited sufficient SPAN margin for open positions by the end of the trading day, he or she would incur a “short margin penalty.”

June 2018: Penalties for Not Collecting SPAN & Exposure

While SPAN data collection was required for all end-of-day positions, exposure margins were optional. In June of 2018, SEBI mandated that brokerages begin collecting exposure margins for all end-of-day positions. This was done once more to reduce the overall market risk.

December 2018 Change in MPOR, or Margin Period of Risk

In December of 2018, the minimum Margin Period of Risk (MPOR) was increased from 1 day to 2 days. This meant that the calculation for the worst-case scenario had to now account for two days, which, as you might expect, resulted in a significant increase in margins.

June 2020 – Review of equity and F&O margin framework

In June 2020, margin requirements became mandatory for trading stocks (F&O Margin collection was made compulsory in Jan 2020, and penalties were implemented from Sep 2020). Changes were made to the way initial margins were calculated in F&O, which greatly benefited customers who hedged their positions and thereby reduced their overall risk. Several significant changes were:

Increased the risk coverage in SPAN from three to six standard deviations. This resulted in an increase in SPAN margins that was offset by a 40% decrease in exposure margins.

The Short Option Minimum (SOM), which increased to 5% for the index and 7.5% for stock F&O in December 2018, was removed. This meant that portfolios with low to zero risk were only required to maintain exposure margins.

Introduction of intraday maximum margin (Dec 2020)

Until now, it was the broker’s responsibility to demonstrate that the customer had sufficient margins for the open position at the end of the trading day (EOD). All exchange-imposed short-margin penalties were based on this EOD position. As long as there was no end-of-day position, a broker could potentially permit customers to trade intraday with high leverages without any margin in their accounts. There was a substantial intraday risk that brokerage firms were assuming, so SEBI decided to address this issue.

The clearing corporation takes snapshots of customer account positions at four random intervals throughout the trading day, as stipulated by the peak margin framework introduced by SEBI. If at any time there is insufficient margin to maintain the position, an intraday peak margin penalty is assessed. Intraday trading contributes significantly to the turnover of the exchanges, and until recently, the majority of intraday trades involved brokers offering additional leverage or requesting margins below the minimum SPAN+Exposure. Since this regulation could potentially have a significant impact, SEBI provided a nine-month transition period.

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