Nifty 17110.15 (-0.97%)
Sensex 57276.94 (-1.00%)
Nifty Bank 37982.1 (0.73%)
Nifty IT 33475.05 (-3.55%)
Nifty Financial Services 17763.15 (-0.15%)
Adani Ports 709.10 (-0.28%)
Asian Paints 3116.95 (-0.96%)
Axis Bank 773.85 (2.88%)
B P C L 382.20 (-0.09%)
Bajaj Auto 3501.10 (0.92%)
Bajaj Finance 6837.00 (-1.82%)
Bajaj Finserv 15359.85 (-1.09%)
Bharti Airtel 707.25 (-0.65%)
Britannia Inds. 3494.15 (-1.28%)
Cipla 927.60 (2.42%)
Coal India 160.55 (-0.37%)
Divis Lab. 3939.85 (-2.70%)
Dr Reddys Labs 4256.35 (-3.33%)
Eicher Motors 2643.85 (-1.79%)
Grasim Inds 1687.05 (-1.99%)
H D F C 2503.35 (-1.08%)
HCL Technologies 1077.75 (-4.09%)
HDFC Bank 1474.95 (-0.88%)
HDFC Life Insur. 621.50 (-1.47%)
Hero Motocorp 2715.00 (-2.41%)
Hind. Unilever 2295.35 (-1.37%)
Hindalco Inds. 489.15 (0.70%)
I O C L 122.70 (1.03%)
ICICI Bank 794.65 (-0.87%)
IndusInd Bank 888.10 (0.44%)
Infosys 1678.60 (-2.53%)
ITC 214.60 (0.14%)
JSW Steel 626.10 (-0.80%)
Kotak Mah. Bank 1889.25 (1.87%)
Larsen & Toubro 1910.85 (-0.75%)
M & M 858.05 (0.42%)
Maruti Suzuki 8820.20 (2.53%)
Nestle India 18385.45 (-2.16%)
NTPC 135.00 (-0.22%)
O N G C 165.70 (0.33%)
Power Grid Corpn 214.85 (-1.83%)
Reliance Industr 2338.10 (-1.48%)
SBI Life Insuran 1211.65 (-1.33%)
Shree Cement 23961.80 (-2.19%)
St Bk of India 528.95 (2.78%)
Sun Pharma.Inds. 812.10 (0.50%)
Tata Consumer 705.95 (-0.25%)
Tata Motors 494.40 (0.78%)
Tata Steel 1088.35 (-1.87%)
TCS 3649.25 (-3.20%)
Tech Mahindra 1445.60 (-3.67%)
Titan Company 2310.05 (-2.80%)
UltraTech Cem. 7100.70 (0.03%)
UPL 771.95 (-2.43%)
Wipro 544.75 (-3.19%)

The Concept

The concept of 'margin' is one of the primary factors to consider and understand for any trader who aims to trade in the share markets. This technique is one of the key premises on which risk management is controlled when the market tends to get volatile. The margin amount helps one tide over any form of price volatility. It also ensures that there is no counter-party default while trading.

What is margin?

Margin, in simple terms, is an exchange introduced risk management procedure. Let us understand the concept in detail through a simple example.

An investor has a bullish view on the market and purchases 2,000 shares of ‘ABC’ company at Rs100 on March 05, 2018. To complete the transaction, he/she has to make a payment of Rs2,00,000 (2,000x100) to his broker on or before March 06, 2018. The broker, in turn, has to provide this money to the respective stock exchange through which the transaction occurred by March 07, 2018. In this situation, there is always a risk that the investor may not be in a position to oblige the trade by the required date.

In order to deal with this issue, the broker collects an upfront token amount from the client. The stock exchange then collects a similar amount from the broker upon execution of the order. This initial amount that was collected is known as 'margin'.

The margin amount is collected for both the buyer and the seller of the shares in order make sure that both parties oblige to the contract. It is collected from the seller to ensure that he delivers the shares sold, while it is collected from the buyer so that he brings the money and is serious about the transaction.

Consider the following situations:



Let us consider a scenario where the margin amount collected is 12%. The buyer has to make a payment of Rs.1,20,000 (10,00,000*0.12) to the broker at the time of the transaction. Assume that Jubilant Life Sciences closes at Rs800 due to selling pressure. With this, the total value of the shares comes down to Rs.8,00,000. The notional loss that the buyer suffers is Rs.2,00,000, which is higher than the margin amount provided. In such a scenario, the buyer may not desire to pay Rs.10,00,000 for the shares whose value has come down to 8,00,000.



Similarly, if the price of the scrip goes up Rs.200 by the end of the trading session, the seller may not want to tender the shares at Rs.1,000 and may even consider forfeiting the margin amount of 12%.

To ensure that both buyers and sellers fulfill their obligations irrespective of the price movements, notional losses are also collected. As share prices change every day, margins ensure that buyers bring money and sellers bring shares to complete the transaction even though the prices have moved against them.

Impact of volatility on margins

Price movement varies considerably from one scrip to another. Some stocks witness large price swings while others trade in a narrow range.


In the above example, we have the historical volatility of four stocks. Historical volatility provides an estimation of stock price movement based on past price movement. No analyst would be able to predict the closing price of the stock on a given day. However, historical volatility numbers would help us tell that DLF may move up or down by a larger percentage compared to the rest of the stocks, whereas HUL may see the least variation from its previous day’s closing price.

Since the uncertainty in price movement (risk) is the highest for DLF, it would also attract the highest initial margin, whereas shares of HUL and ITC would attract lower initial margin, since their volatility is low.

Margins levied in the cash market segment

a) Value at risk (VaR): VaR is the main margining system in the cash market. It is collected at the time of placing the order. It provides information regarding how much a security is likely to move over the next trading session. It is a technique used to estimate the probability of loss of an asset or group of assets, based on statistical analysis of historical price trends and volatilities. It tries to answer what is the maximum value that an asset or portfolio could lose over the next trading session with 99% confidence.

Consider that an investor has purchased shares worth one crore. Through the VAR methodology, the investor may say that the one-day VAR is Rs.5 lakh at 99% confidence level. This implies that under normal trading conditions, the stock will not fall more than Rs5 lakh within the next trading session. This can be stated with confidence.

Put simply, VaR is a margin intended to cover the largest loss (in %) that an individual faces on his / her shares (both purchases and sales) on a single day.

b) Extreme loss margin: Extreme loss margin tries to cover the margin that falls outside the coverage of VaR margin. The extreme loss margin for a security is 1.5 times the standard deviation of daily log returns of the stock’s price in the last six months or 5 % of the value of the position, whichever is higher.

Suppose the standard deviation of daily log returns of the security is 4%, then 1.5 times the standard deviation would be 6%. Then 6%, which is higher than 5%, would be taken as the extreme loss margin.

Therefore, the total margin which is paid upfront is 'VaR + Extreme loss margin'.

c) Mark to market (M2M) margin: This margin has to be paid before the start of the next trading session unlike the above two, which have to be paid at the time of the transaction.

MTM is computed by taking the difference between the transaction price and the closing price of the share for the day. MTM is collected so that the buyer and seller deliver on the transaction even if the trade goes against them by the end of the session.

Considering the example we had seen at the start of the chapter:

MTM Profit/Loss = [(Total Buy Qty x Close price) – Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close price)]

Margin in the derivatives market

Margin plays a crucial role in the derivatives market, which is highly leveraged and speculative in nature. Shares traded in the cash market are settled in two days, whereas derivative contracts may require a longer time to expire. Since derivative market margins have to address the uncertainty over a longer period of time, markets regulator Securities and Exchange Board of India (SEBI) has prescribed a different method to calculate margin in the segment.

Margin in the derivatives segment comprises of the following:

a) Initial margin

b) M2M settlement

Let's have a closer look at them.

Initial margin

The initial margin is like a down payment on a loan. Just as we have to pay a minimal amount to buy something with a loan, in the case of exchange traded derivatives, we need to pay a certain amount in the form of an initial margin. Initial margin is a percentage of the contract value, which is calculated at the time of initiating the contract.

1. At the time of creating the futures position, initial margin gets blocked in the trading account

2. The initial margin is made up of two components, i.e. SPAN margin and the exposure margin

Initial margin = SPAN margin + exposure margin

SPAN margin: SPAN, which stands for Standard Portfolio Analysis of Risk, is a product developed by the Chicago Mercantile Exchange (CME). Leading stock exchanges across the world extensively use this product, which uses a scenario based approach to arrive at margin amounts.

Value of futures and options positions depend on, among other things, the price of the security in the cash market and its volatility. Since the price of the security and its volatility constantly change, SPAN generates about 16 different scenarios by assuming different values to the price and volatility.

The possible loss that the portfolio would suffer is calculated in each of these scenarios. 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. SPAN margins are revised 6 times in a day - once at the beginning of the day, four times during market hours, and finally at the end of the day (NSE).

Exposure margin: Exposure margin, in respect of index futures and index option sell positions, are 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 1.5x the standard deviation of the log normal returns of the security (in the underlying cash market) over the last six months and is applied on the notional value of the position (NSE).

3. Initial margin is blocked in the trading account till you square of your position.




Mark to Market

We know that F&O prices fluctuate on a daily basis, on virtue of which you either stand to make a profit or a loss. Mark to market (M2M) is a simple accounting procedure which involves adjusting the profit or loss you have made for the day and entitling you the same. As long as your futures position is open, M2M is applicable.

Let us take up a simple example to understand this well


M2M: Long position

Initial margin: Rs.63,113

Maintenance margin is usually set at SPAN margin. If loss incurred is higher, margin call is triggered. I.e. if the margin amount dips below 39120 (10519*75*0.05)




In the above example, the trader has initiated a long position in Nifty futures on March 1, 2018. The initial margin that he pays is Rs.63,113. Unfortunately for the trader, his view does not go as expected and the market witnesses a correction in the following days. On the 4th trading day, the trader receives a margin call as his initial margin dips below the minimum maintenance margin set by the broker i.e. 18,933 (30% of 63,113). At this point, the trader has two options i.e. either close out his position or top up his account back to the initial margin. The trader feels that the market would bounce back and considers to continue holding his long position by infusing fresh capital.

The initial margin would now be calculated taking the market price on March 6 and has to be deposited before the start of the next trading session.

Initial margin = 10,171 (Nifty closing price on March 6)*0.08 (total margin) = Rs.61,026

Since there is already a balance of Rs.37,013 in the account, the additional infusion that has to be done is Rs.24,013.

The initial margin will be released the moment the trader squares off his position in the market.

A similar M2M settlement procedure is followed when a trader initiates a short position in Nifty futures.

SEBI’s latest directives on margin in derivatives

SEBI, on May 02, 2018, came out with a circular on additional risk management measures in the derivatives segment.

From June 1, 2018, onwards, clients trading in futures or writing options would have to maintain a margin amount that covers ‘SPAN+Exposure’ after considering any mark to market losses. Until now, some brokers used to charge only the SPAN margin from clients to take a new position.

In the above example of Nifty Futures, the client was required to meet the margin call when his M2M losses dipped below his SPAN margin, i.e. 39,120, or he would invite a penalty from the exchange or have to close his position. Going forward, from June, the client will have to maintain a total margin of Rs.63,113 at all times to continue holding his derivatives position overnight without having to pay the short margin penalty, something which exchanges used to charge earlier whenever margins fell below stipulated SPAN levels.



From the above example, we see that the client would have to maintain an initial margin that covers both SPAN and exposure margins at all times, according to the new SEBI guidelines. Each time his/her margin dips below the initial margin because of M2M losses, he/she would have to top it up by the same amount each day to carry forward his position.

Further clarification on the circular is awaited.


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