gopalakrishna

Two type of margins have been specified -

o 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.

o 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 (3σ ) where ‘σ ’ is the volatility estimate of the Index. The volatility estimate ‘σ ’, 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 σ) where ‘σ’ 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) * 3.5σ or approx. 6.06σ. For stocks with impact cost of 1% or less, the price scan range would remain at 3.5σ.

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 σ 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 option products.

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:-

o 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.

o 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.

CONDITIONS FOR LIQUID NETWORTH

Liquid net worth means the total liquid assets deposited with the clearing house towards initial margin and capital adequacy; LESS initial margin applicable to the total gross open position at any given point of time of all trades cleared through the clearing member.

The following conditions are specified for liquid net worth:

o Liquid net worth of the clearing member should not be less than Rs 50 lacs at any point of time.

o Mark to market value of gross open positions at any point of time of all trades cleared through the clearing member should not exceed the specified exposure limit for each product.

Liquid Assets

At least 50% of the liquid assets should be in the form of cash equivalents viz. cash, fixed deposits, bank guarantees, T bills, units of money market mutual funds, units of gilt funds and dated government securities. Liquid assets will include cash, fixed deposits, bank guarantees, T bills, units of mutual funds, dated government securities or Group I equity securities which are to be pledged in favor of the exchange.

Collateral Management

Collateral Management consists of managing, maintaining and valuing the collateral in the form of cash, cash equivalents and securities deposited with the exchange. The following stipulations have been laid down to the clearing corporation on the valuation and management of collateral:

o At least weekly marking to market is required to be carried out on all securities.

o Debt securities of only investment grade can be accepted.10% haircut with weekly mark to market will be applied on debt securities.

o Total exposure of clearing corporation to the debt or equity of any company not to exceed 75% of the Trade Guarantee Fund or 15% of its total liquid assets whichever is lower.

o Units of money market mutual funds and gilt funds shall be valued on the basis of its Net Asset Value after applying a hair cut of 10% on the NAV and any exit load charged by the mutual fund.

o Units of all other mutual funds shall be valued on the basis of its NAV after applying a hair cut equivalent to the VAR of the units NAV and any exit load charged by the mutual fund.

o Equity securities to be in demat form. Only Group I securities would be accepted. The securities are required to be valued / marked to market on a daily basis after applying a haircut equivalent to the respective VAR of the equity security.

Mark to Market Margin

Options – The value of the option are calculated as the theoretical value of the option times the number of option contracts (positive for long options and negative for short options). This Net Option Value is added to the Liquid Networth of the Clearing member. Thus MTM gains and losses on options are adjusted against the available liquid networth. The net option value is computed using the closing price of the option and are applied the next day.

Futures – The system computes the closing price of each series, which is used for computing mark to market settlement for cumulative net position. If this margin is collected on T+1 in cash, then the exchange charges a higher initial margin by multiplying the price scan range of 3 σ & 3.5 σ with square root of 2, so that the initial margin is adequate to cover 99% VaR over a two days horizon. Otherwise if the Member arranges to pay the Mark to Market margins by the end of T day itself, then the initial margins would not be scaled up. Therefore, the Member has the option to pay the MTM margins either at the end of T day or on T+1 day.

Summary of parameters specified for Initial Margin Computation

Index Options


Index Futures


Stock Options


Stock Futures


Interest Rate Futures


Price Scan Range

3 sigma


3 sigma


3.5 sigma


For order size of Rs.5 Lakh, if mean value of impact cost > 1%, the Price Scan Range be scaled up by √3(in addition to look ahead days)


3.5 sigma For order size of Rs.5 Lakh, if mean value of impact cost > 1%, the Price Scan Range be scaled up by √3(in addition to look ahead days) For long bond futures, 3.5 sigma and for notional T-Bill futures, 3.5 sigma.


Volatility Scan Range


4%


10%


Minimum margin requirement


5%


7.5%


For long bond futures, minimum margin is 2%. For notional T-Bill futures minimum margin is 0.2%.

Short option minimum charge


3%


7.5%


Calendar Spread



0.5% per month on the far month contract (min of 1% and max 3%)

Mark to Market



Net Option Value (positive for long positions and negative for short positions) to be adjusted from the liquid networth on a real time basis.

The daily closing price of Futures Contract for Mark to Market settlement would be calculated on the basis of the last half an hour weighted average price of the contract.



MARGIN COLLECTION

Initial Margin - is adjusted from the available Liquid Networth of the Clearing Member on an online real time basis.

Marked to Market Margins-

Futures contracts: The open positions (gross against clients and net of proprietary / self trading) in the futures contracts for each member are marked to market to the daily settlement price of the Futures contracts at the end of each trading day. The daily settlement price at the end of each day is the weighted average price of the last half an hour of the futures contract. The profits / losses arising from the difference between the trading price and the settlement price are collected / given to all the clearing members.

Option Contracts: The marked to market for Option contracts is computed and collected as part of the SPAN Margin in the form of Net Option Value. The SPAN Margin is collected on an online real time basis based on the data feeds given to the system at discrete time intervals.

Client Margins

Clearing Members and Trading Members are required to collect initial margins from all their clients. The collection of margins at client level in the derivative markets is essential as derivatives are leveraged products and non-collection of margins at the client level would provide zero cost leverage. In the derivative markets all money paid by the client towards margins is kept in trust with the Clearing House / Clearing Corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the dues of the defaulting member.

Therefore, Clearing members are required to report on a daily basis details in respect of such margin amounts due and collected from their Trading members / clients clearing and settling through them. Trading members are also required to report on a daily basis details of the amount due and collected from their clients. The reporting of the collection of the margins by the clients is done electronically through the system at the end of each trading day. The reporting of collection of client level margins plays a crucial role not only in ensuring that members collect margin from clients but it also provides the clearing corporation with a record of the quantum of funds it has to keep in trust for the clients.