Hello readers, I hope you have read our last blog on margin trading facilities. But, today we are going to talk about various types of margin in the stock market. The customer must deposit a certain amount of money with the broker in order to buy or sell stocks on the exchange. The margin is the name given to this amount of money. The degree of margin required by traders is determined by the exchange, as is the case with many other regulations, depending on the amount of volatility and volume. so let's take a deep dive into the types of margin in the stock market.
Just as we are faced with day-to-day uncertainties about the weather, health, traffic, etc, and take steps to minimize the uncertainties, so also in the stock markets, there is uncertainty in the movement of share prices. This uncertainty leading to risk is sought to be addressed by margining systems by stock markets.
Margins in the cash market segment comprised of the following three types:
1) Value at Risk (VaR) margin:
VaR Margin is at the heart of the margining system for the cash market segment. Let us try and understand briefly what we mean by ‘VaR’. The most popular and traditional measure of uncertainty/risk is Volatility, Technically, VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for example a share or a portfolio of a few shares), based on the statistical analysis of historical price trends and volatilities
VaR is computed using exponentially weighted moving average (EWMA) methodology. Based on statistical analysis, 94% weight is given to volatility on ‘T-1’ day and 6% weight is given to ‘T’ day returns.
2) Extreme loss margin
The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR margins
3) Mark to market Margin
MTM is calculated at the end of the day on all open positions by comparing transaction price with the closing price of the share for the day
The initial margin for the F&O segment is calculated based on a portfolio (a collection of futures and option positions) based approach. The margin calculation is carried out using software called - SPAN® (Standard Portfolio Analysis of Risk). It is a product developed by Chicago Mercantile Exchange (CME) and is extensively used by leading stock exchanges of the world. The SPAN® margins are revised 6 times in a day - once at the beginning of the day, 4 times during market hours, and finally at the end of the day. Higher the volatility, the higher the margins.
In addition to the initial / SPAN® margin, exposure margin is also collected. Exposure margins in respect of index futures and index option sell positions have been currently specified as 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 1.5 standard deviation of the LN returns of the security (in the underlying cash market) over the last 6 months period and is applied on the notional value of the position.
The extreme loss margins for options and futures contracts on index and stocks are as follows:
|PRODUCT||EXTREME LOSS MARGIN|
|Index Derivatives||2% of the notional value|
|Stock Derivatives||3.5% of the notional value|
For this purpose, notional value means:
|ON INTRADAY BASIS||crystallized obligations based on the closed-out futures positions and it is payable/receivable premium at the client level.|
|AT END-OF-DAY||Obligations at client level considering all futures and options positions.|
On an intraday basis, the net payable/receivable amount at the client level is:
If the overall amount at the client level is payable, such amount is the intraday consolidated crystallized obligation margin for the client.
End-of-day basis At the end of the day, the payable/receivable amount at the client level shall be calculated using:
If the overall amount at the client level is payable, such amount is the end-of-day consolidated crystallized obligation margin for the client. The margin on consolidated crystallized obligations shall be released on completion of settlement.
Mark to market loss is calculated by marking each transaction in security to the closing price of the security at the end of trading. The mark to market margin (MTM) is collected from the member before the start of the trading of the next day. At every End of the day, the difference of the cost bought/sold vs Closing price calculated and the Loss so on the said position is considered as MTM loss.
With the guideline issued by SEBI, Brokers need to collect upfront margins in the form of funds/securities by way of Fund transfer or Margin Pledge (Specifically read as Clear Funds &/or Securities) to execute any transactions. It has primarily to restrict from providing additional leverage over and above what VAR+ELM ( with minimum 20% for stocks) and SPAN + Exposure (F&O – Equity, Commodity, Currency) already offer.
Starting Dec 1st, 2020, the maximum intraday leverage that can be offered by a broker will be restricted and this maximum leverage will keep reducing until Sep1’st 2021 post which a broker can give maximum leverage = VAR+ELM(min 20%) or SPAN+Exposure. Until now, the reporting for margin requirements happened based on end-of-day positions.
Based on these positions, the exchange was imposing a margin on the customer. Under peak margin reporting, Exchange shall send 4 Snapshots in a day on scheduled time (In a random, system-driven process). At the end of the day, Exchange will consider the maximum margin across that 4 snapshots/Margin files for any client which will be considered as Peak Margin.
Higher the shortfall in collection of the margin obligations at (a) and (b) above, shall be considered for levying of penalty as per the extant framework.
So, this is it about types of margin in the stock market. let us know how was it by commenting below. and explore more opportunities to invest and grow by Clicking here.
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