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Chapter 4 Margins, Mark to Market and Settlements

Margins

Two types of margins are determined daily: Initial Margin and Mark-to-Market Profit/Loss. Initial margin on the future market is computed by using Value-at-Risk (VaR). Initial margin amount, computed using VaR, is collected up-front from buyers and sellers.

At the time of initiating the futures position, margin is blocked in your trading account. The initial margin is made up of two components i.e. SPAN margin and the Exposure Margin. Initial Margin will be blocked in your trading account for the number of days you choose to hold the futures trade. The value of initial margin varies daily as it depends on the futures price volatility. Remember, Initial Margin = % of (Futures Price * Lot Size). Lot Size is fixed, but the futures price varies every day.

Symbol NIFTY 31-Aug-17
Current Future Price 9,919
Lot Size 75
Contract Value (Future Price * Lot Size) 743,925
Initial Margin @ 5% 37,196
Exposure Margin @ 3% 22,317
Total Initial Margin (Rs) 59,513

Mark to Market

The daily settlement process is called Mark to Market. It provides for collection of losses that have already occurred. The mark-to-market settlement is done in cash.

Mark to Market - Long Position

Assumption: Initial Margin is Rs. 59,500.

Day Beginning Balance Funds Deposited Nifty Close Settlement Price Future Price Change Gain /Loss Ending Balance
0 0 59,500 9900 742,500 0 0 59,500
1 59,500 0 9850 738,750 -50 -3,750 55,750
2 55,750 0 9750 731,250 -100 -7,500 48,250
3 48,250 0 9920 744,000 170 12,750 61,000
4 61,000 0 9945 745,875 25 1,875 62,875
5 62,875 0 9935 745,125 -10 -750 62,125
6 62,125 0 9950 746,250 15 1,125 63,250

Net Profit/ Loss From the trade = (63250-59500) = Rs. 3750

Mark to Market - Short Position

Assumption: Initial Margin is Rs. 59,500.

Day Beginning Balance Funds Deposited Nifty Close Settlement Price Future Price Change Gain /Loss Ending Balance
0 0 59,500 9900 742,500 0 0 59,500
1 59,500 0 9850 738,750 -50 3,750 63,250
2 63,250 0 9750 731,250 -100 -7,500 70,750
3 70,750 0 9920 744,000 +170 -12,750 58,000
4 58,000 0 9945 745,875 +25 -1,875 56,125
5 56,125 0 9935 745,125 -10 750 56,875
6 56,875 0 9950 746,250 +15 -1,125 55,750

Net Profit/Loss From the trade = (55,750- 59,500) = Rs. -3,750

Settlement of derivatives contracts

All the Futures and Options contracts are settled in cash on a daily basis and at the expiry or exercise of the respective contracts as the case may be. As a trader, you can exit the future position by taking an opposite position. Therefore, if you are a buyer, you have to sell the same contract of the same quantity. On the other hand, if you are a seller, you need to buy the same contract of same quantity. This process of exiting is also known as Square-off.

Once the position is squared off, you are free from all obligations and the contract ceases to exist. If any position is not squared off, such positions are taken on the closing price of Stock (not the future) of the expiry date. The closing price is the average price of the stock in the last half an hour of trading.

Derivatives markets can be extremely volatile and there are no circuit breakers. Prices can move up or down sharply, resulting in very favorable or unfavorable situations for you. Hence, you need to monitor your positions regularly.

Key Takeaways

  • Initial margin varies daily as it depends on the futures price volatility.

  • Initial Margin = % of (Futures Price * Lot Size).

  • Daily settlement process is called Mark to Market.

  • Futures and Options contracts are settled in cash.

  • Stock price movement in derivatives market can be extreme as there are no circuit filters.

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