1. Why should there be margins?
    Just as we are faced with day to day uncertainties pertaining to 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 of
    stock markets.

    Suppose an investor, purchases 1000 shares of ‘xyz’ company at Rs.100/- on January 1, 2008. Investor has to give the purchase amount of Rs.1,00,000/- (1000 x 100) to his broker on or before January 2, 2008. Broker, in turn, has to give this money to stock exchange on January 3, 2008.

    There is always a small chance that the investor may not be able to bring the
    required money by required date. As an advance for buying the shares, investor is
    required to pay a portion of the total amount of Rs.1,00,000/- to the broker at the
    time of placing the buy order. Stock exchange in turn collects similar amount from
    the broker upon execution of the order. This initial token payment is called margin.

    Remember, for every buyer there is a seller and if the buyer does not bring the
    money, seller may not get his / her money and vice versa.

    Therefore, margin is levied on the seller also to ensure that he / she gives the 100 shares sold to the broker who in turn gives it to the stock exchange.

    Margin payments ensure that each investor is serious about buying or selling shares.

    In the above example, assume that margin was 15%. That is investor has to give
    Rs.15,000/-(15% of Rs.1,00,000/) to the broker before buying. Now suppose that
    investor bought the shares at 11 am on January 1, 2008. Assume that by the end of the day price of the share falls by Rs.25/-. That is total value of the shares has come down to Rs.75,000/-. That is buyer has suffered a notional loss of Rs.25,000/-. In our example buyer has paid Rs.15,000/- as margin but the notional loss, because of fall in price, is Rs.25,000/-. That is notional loss is more than the margin given.

    In such a situation, the buyer may not want to pay Rs.1,00,000/- for the shares whose value has come down to Rs.75,000/-. Similarly, if the price has gone up by
    Rs.25/-, the seller may not want to give the shares at Rs.1,00,000/-. To ensure
    that both buyers and sellers fulfill their obligations irrespective of price movements, notional losses are also need to be collected.

    Prices of shares keep on moving every day. Margins ensure that buyers bring money and sellers bring shares to complete their obligations even though the prices have moved down or up.
  2. What is volatility?
    Different people have different definitions for volatility. For our purpose, we can say that volatility essentially refers to uncertainty arising out of price changes of shares. It is important to understand the meaning of volatility a little more closely because it has a major bearing on how margins are computed.
  3. Is volatility linked to the direction of price movements?
    No. Stock prices may move up or may move down. Volatility will capture the extent of the fluctuations in the stock, irrespective of whether the prices are going up or going down. In the above example shares of ‘X’ have moved up steadily whereas shares of ‘Y’ moved down steadily. However, both have same historical volatility.
  4. Are margins same across cash and derivatives markets?
    Stock market is a complex place with variety of instruments traded on it. As shown above, one single margin for all shares may not be able to handle price uncertainty / risk. In our simple example under question 1, even within cash market, we have seen two types of margins, one at the time of placing the order and another to cover the notional loss.

    Shares traded on cash market are settled in two days whereas derivative contracts may have longer time to expiry. That is, derivative market margins have to address the uncertainty over a longer period.

    Therefore, SEBI has prescribed different ways to margin cash and derivatives
    trades taking into consideration unique features of instruments traded on these
  5. What are the types of margins levied in the cash market segment?
    Margins in the cash market segment comprise of the following three types:
    • Value at Risk (VaR) margin
    • Extreme loss margin
    • Mark to market Margin
  6. How is Mark-to-Market (MTM) margin computed?
    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. In our example in question number 1, we have seen that a buyer purchased 1000 shares @ Rs.100/- at 11 am on January 1, 2008. If close price of the shares on that day happens to be Rs.75/-, then the buyer faces a notional loss of Rs.25,000/- on his buy
    position. In technical terms this loss is called as MTM loss and is payable by January 2, 2008 (that is next day of the trade) before the trading begins.

    In case price of the share falls further by the end of January 2, 2008 to Rs. 70/-, then buy position would show a further loss of Rs.5,000/-. This MTM loss is payable by next day.

    In case, on a given day, buy and sell quantity in a share are equal, that is net quantity position is zero, but there could still be a notional loss / gain (due to difference between the buy and sell values), such notional loss also is considered for calculating the MTM payable.

    MTM Profit/Loss = [(Total Buy Qty X Close price) – Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close price)]
  7. What are the types of margins levied in the Futures & Options (F&O) Segment?
    Margins on both Futures and Options contracts comprise of the following:
    • Initial Margin
    • Exposure margin
    In addition to these margins, in respect of options contracts the following additional margins are collected
    • Premium Margin
    • Assignment Margin
  8. Do I get margin benefit if I have positions on different underlyings?
    No. Margin benefit is not provided for positions on different underlyings in F&O segment.
  9. Do I get margin benefit if I have positions in both futures and options on same underlying?
    Yes. Margin benefit is provided for positions in futures and options contracts on the same underlying.
  10. Do I get margin benefit if I have counter positions in different months on same underlying?
    Yes. In case of calendar spread positions margin benefit is provided. However, the benefit is removed three days prior to expiry of the near month contract.