The aim of margin money is to minimize the risk of default by either counter-party. The payment of margin ensures that the risk is limited to the previous day's price movement on each outstanding position. However, even this exposure is offset by the initial margin holdings.
Margin money is like a security deposit or insurance against a possible future loss of value.
What are the different types of Margins levied on Derivative Contracts?
There are two types of margin levied on Derivatives Contracts. One is Initial Margin using the concept of Value at Risk and shall cover one-day loss that can be encountered on the position on 99% of the days and the other is Mark-to-Market Margin. Initial Margin is collected upfront and Mark-to-Market Margin on T+1 basis.
What is Initial Margin? Why is it charged?
The Initial Margin is the percentage of the purchase price of futures contract that the investing client needs to pay to the broker on an up-front basis before taking the position. Both buyer and seller have to deposit this margin. The Trading Members will buy and/or sell derivatives contracts on behalf of the clients only on the receipt of initial margin, unless the client already has an equivalent credit with the Trading Member. For futures contracts, initial margin requirements are set by the exchange.
The basic aim of Initial margin is to cover the largest potential loss in one day. This margin is calculated by SPAN by considering the worst case scenario.
The initial margin charged for spread positions taken up in derivatives contract is much lower than non � spread positions since the risk involved in spread positions is much lower.
When does the client need to pay Initial Margin to the broker?
The client needs to pay initial margin to the broker on an up-front basis before taking either buy or sell position in a futures contract.
What is Variation or Mark-to-Market Margin?
In the Daily Settlement cycle, all open futures positions are marked to market at the daily settlement price. This means that the difference between the Net Traded Value of the futures position in any contract and the value of the open position in the same contract at the futures closing price (Mark to Market Value) is calculated. Any profit arising out of this difference is paid out to the client on T+1 day, while losses arising on the open position are required to be paid to the exchange on T+1 day. Thus Variation or Mark to Market Margin can be defined as the daily profit or loss obtained by marking the members outstanding position to the market (closing price of the day.)
Is it compulsory for the client to pay Mark to Market margin?
Trading members are required to pay mark to market margin to the exchange for the open positions of all their clients in futures contracts. It is compulsory for clients to meet their mark�to�market obligations towards the Trading member for any losses arising on their open positions. Similarly, profit on the same will be credited to the account of the client by the Trading member.
What is SPAN Margin?
SPAN is short for Standardized Portfolio Analysis of Risk. This is a leading margin system, which has been adopted by most options and futures exchanges around the world. SPAN is based on a sophisticated set of algorithms that determine margin according to a global (total portfolio) assessment of the one-day risk for a trader's account. This risk is calculated on the basis of worst possible one-day move.
What steps can be taken by the Trading member in case of non-payment of margin by the client?
In case of non-payment of daily settlement by the client within the next trading day, the Trading Member has the liberty to square up the client�s position by selling or buying the derivatives contracts, as the case may be, unless the constituent already has an equivalent credit with the Trading Member. The loss incurred in this regard, if any, shall be met from the margin money of the client.
Can the investor square up his position any time before expiry?
The investor can square up his position at any time till the expiry. The investor can first buy and then sell stock futures to square up or can first sell and then buy stock futures to square up his position.
What are Daily Settlement and Final Settlement?
Daily Settlement: At the end of each trading session, Daily Settlement takes place. The outstanding positions are marked to market at the daily settlement price. This means that the difference between the Net Traded Value of the futures position in any contract and the value of the open position in the same contract at the futures closing price (Mark to Market Value) is calculated. Any profit arising out of this difference is paid out to the client on T+1 day, while losses arising on the open position are required to be paid to the exchange on T+1 day.
Daily Settlement Price used for calculating the Mark to market positions, is the futures closing price calculated by taking the half an hour, weighted closing futures price. The outstanding positions are brought forward to the next working day at the Daily Settlement Price calculated in this manner.
Final Settlement: The Final Settlement of the current month contract takes place on the last trading which is the last Thursday of Contract Expiry Month. In case the last Thursday is a public holiday, the Final settlement is done on the previous working day. In case of final settlement, the outstanding positions are closed out at the Final Settlement Price, which is the closing price of the underlying (stock or index) in the cash market. The net difference is credited or debited, as the case may be, on the T+1 day. This completes the entire settlement process for that contract.
After the Final Settlement that contract gets invalidated and a new contract gets introduced automatically for three-month maturity. For example, if the 3 futures contracts in a particular stock expire on 29th June, 27th July and 31st August respectively (these being the last Thursdays of the respective months), the final settlement for the first contract will be done on 29th June. On 30th June, the September contract will come into existence expiring on 28th of September. Therefore, at any point of time, near 3-month contracts are available for trading.
Are Stock Futures settled in cash or by giving / taking delivery of underlying stock?
Presently, Stock futures are settled in cash.
How is the Final Settlement Price determined?
The closing value of underlying Index / stock in the cash market is taken as the final settlement price of the index / stock futures contract on the last trading day of the contract for settlement purpose.
