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.