DRAFTChanges in the Margin System w.e.f. 01-Jun-20

28-May-2020Online

We start at 4:30 sharp ☺

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DRAFT

Framework

• Framework provides the set of rules which are used tocompute the margin.• Base minimum to be charged by Clearing Corporations (CC)

• CC may charge higher

• Same for brokers, can charge higher than CC

• Framework works across segments• Ensures consistency of margin on the same underlying for even

cross segment positions like Cash – Future

• Commodity derivatives exception - different nature of underlying

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Framework v/s collection

• Margin collection and reporting relates to the collection ofmargins by CM from TM and TMs from the clients• This is not framework

• New framework will apply to both cash equities and equityderivatives• Collection/ Reporting/ Penalties may be different across Equity

and derivatives segments

• Regulatory prerogative

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Margins in India - Brief history

• Exchanges wanted to start in 1998 but SCRA act did nothave provisions to allow derivative.

• So Shri L. C. Gupta committee suggested the framework toparliament and SCRA act was amended on the lines of whathe suggested• A SPAN based margin supported by a second level ELM (extreme

loss margin or exposure margin designed to avoid”overspeculation”) as a second line of defense against movesbeyond 3 sigma (99.6%)

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Process of the change

• The basic architecture of margining system remainedunchanged for two decades.• However SEBI circular SEBI/HO/MRD/DRMNP/CIR/P/2018/155

dated 17-Dec-2018 increased MPOR and SOMC

• Market demands to review the old system

• Request for change• Referred to SEBI RMRC sub-committee to review framework

• New framework notified on 24-Feb-2020 vide SEBI circularSEBI/HO/MRD2/DCAP/CIR/P/2020/27

• Comes into effect from 01-Jun-20205

DRAFT

Terms – MPOR and SOMC

• MPOR- Margin period of Risk• This is the duration over which movement of stock prices is

considered for margining. MPOR of 2 means margin should coverthe risk of price movement across 2 days. Daily price movement ismultiplied by square root of MPOR. E.g. MPOR of 2 days is MPOR(1 day) * 1.41, MPOR of 3 is MPOR (1 day) * 1.73

• SOMC- Short option minimum charge• This is the minimum initial margin charged if an option is sold

irrespective of whether there is any risk . Say if you buy future andsell a call (so there is no risk from the short option), the optionssale will still be subject to this margin

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Terms – PSR

• PSR- Price scan range• This is the range of price movement over which the worst case

loss to the position is to be assessed. E.g If PSR for index is 10%and index is at 9000 we will see between 8100 and 9900 wherewill the portfolio have maximum loss.

• For futures this point is high or low value (8100 for a longposition) but for options the point of max loss may be somewhereelse (eg if I buy 9000 put and sell 9100 put my max loss is at9100). As volatility increases the sigma range increases and sodoes the margin.

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Summary of the effect

• xxx

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Terms - λ Lambda

• Weightage used for computing Exponential weightedmoving average

• When volatility is computed it could either simple (say sumof last 250 observations /250 ).

• In order to give more weightage to recent movements aweightage is assigned to each of the observation so thatrecent changes have more weightage

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Terms - Sigma σ

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Changes in a nutshell - 1

• PSR of 3.5 σ is now 6 σ• While intuitively the margin should jump but this is where the

change in λ matters. Earlier the last day had a weightage ofaround 6% and so the last 70 days movement was very important.Under the new model since the last days weightage is just 0.5% sothe last one years movement is important and is almost equallyweighted. Which means single days abrupt movement wontimpact the price range but a sustained price volatility will keep themargins high for long. Since the now almost annualized volatility isused even using 6 σ doesn’t increase the margins significantlyexcept in volatile stocks

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Changes in a nutshell - 2

• The minimum margins have been permanently kept at theMay 2019 level adjusted for exposure margin• e.g. NIFTY was 7.1 + 4.2% now minimum initial margin is 9.3 + 2%

exposure• This is designed to avoid pro cyclicality as margins remain

permanently elevated even if 6 σ is lower• This will also hopefully reduce the need to apply adhoc margin• Corollary - Margins will never reduce back to pre 2018 levels.

• Removal of SOMC• Options positions which are hedged are charged a far lower

margin than the old system reflecting the lower risk in suchpositions

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DRAFT

Special cases - FnO

• For Index futures and options calendar spreads• SPAN margin - 1.75% of the far month contract

• ELM - 1/3 of 2% for futures, 2% for options short

• For far away options some extra margins• Index options beyond 10% from index price - ELM 3%

• Index options more than 9 months - ELM 5%

• For Single Stock Futures (SSF) calendar spreads• SPAN 2.2% of far month

• ELM is 1/3 of 3.5%

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Special cases – High Volatility SSF

• For high volatility stocks where price movement [H-L |H-PrC|PrC -L] >10% for more than 3 days in a month• Minimum margin will be equal to the highest price movement (in

%) till three months

• For consistent high volatility stocks where the above morethan 10% criteria is met more than 10 days in last 6 months• Highest movement (in %) will be the minimum margin till one year

after the introduction of such minimum margin

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Margin Computation Steps - FO

• Step 1 : Initial margin is computed on portfolio (i.e.underlying) basis.

• Step 2 : Offset for current month and then calendar spreadbenefit will be computed

• Step 3 : Exposure margin for each of the futures legs andshort options with suitable calendar spread benefits whereavailable

• Step 4: Margins across all underlying are added to arrive atthe final number

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Margin computation – Cash Mkt

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Liquidity Group VaR Margin Rate

Group 1 Based on 6σ, subject to minimum of 9% Group(6% for index ETF)

Group 2 Based on 6σ, subject to minimum of 21.5% Group

Group 3 50% if traded atleast once per week on any stock exchange; 75% otherwise

ELM 3.5 for all stocks and 2% for index ETF

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Impact on USD/INR

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Margins Rates

Initial margin Based on 6σ, subject to the minimum 1.5%

ELM Futures - 0.50%, Options 0.75%

SOMC Nil

Volatility Scan Range (VSR)

25% of annualized EWMA volatility (Min 3% )

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Margin Change – Index

• BankNifty• 20.10% becomes 23.76% (26-May-2020)

• Nifty• 23% becomes 19% (15-Apr-2020)

• 15.20% becomes 18.72% (26-May-2020)

• Sensex• 15.27% becomes 18.91% (26-May-2020)

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Margin Change – Stock Futures

• Margin Increase >= 10%• 50

• Margin increase 0-10%• 47

• Margin fall 0-10%• 40

• Margin fall >10%• 7

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Margin examples - 1

• Long futures (index)• Initial Margin 11% becomes 16.7%

• ELM 4.25% becomes 2%

• Net increase – 3.47%

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SSF - margins fall (26-May)

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Symbol

New Margin %

New Margin Value

Old Margin %

Old Margin Value new/old

IDEA 80.07 439432.00 121.55 667089.92 0.66

M&MFIN 44.74 95200.00 54.74 116481.28 0.82

JINDALSTEL 50.38 272831.25 60.32 326605.95 0.84

ADANIPOWER 45.53 167112.50 52.84 193905.60 0.86

ESCORTS 41.74 398474.45 48.82 466040.29 0.86

JUSTDIAL 46.79 232978.55 52.93 263546.44 0.88

CHOLAFIN 42.33 129426.25 47.37 144835.90 0.89

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SSF - margins increase (26-May)

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SymbolValue New Margin % New Margin Value Old Margin % Old Margin Value new/old

BIOCON 820755 38.32 314547 19.33 158675 1.98

HDFCLIFE 456345 40.43 184506 26.84 122494 1.51

GODREJPROP 390423 41.15 160662 28.29 110452 1.45

NAUKRI 479000 38.99 186783 27.10 129818 1.44

SBILIFE 566063 35.04 198335 24.46 138436 1.43

BANDHANBNK 241440 64.83 156518 45.65 110228 1.42

ADANIENT 557800 50.00 278913 38.73 216039 1.29

BRITANNIA 633560 27.63 175029 21.55 136514 1.28

DLF 450945 34.89 157320 27.40 123566 1.27

MINDTREE 705760 34.88 246158 27.46 193825 1.27

BALKRISIND 824200 31.45 259247 24.96 205685 1.26

SRF 860400 30.61 263329 24.26 208763 1.26

APOLLOHOSP 655800 30.50 200038 24.67 161765 1.24

TORNTPHARM 1282575 25.45 326355 20.59 264028 1.24

BATAINDIA 705815 27.03 190787 21.97 155034 1.23

BERGEPAINT 503140 25.22 126895 20.57 103497 1.23

WIPRO 604800 22.33 135024 18.22 110215 1.23

COLPAL 895545 23.76 212826 19.60 175490 1.21

TATAMOTORS 358405 37.32 133761 30.80 110401 1.21

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Margin examples - 2

• Long futures hedged with buy ATM put• Initial Margin - same (which is Nil)

• Option premium - same

• ELM 4.25% becomes 2%

• Net decrease– 2.25%

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DRAFT

Margin examples - 3

• Long futures hedged with buy OTM (500 pts) put• Initial Margin – 500 points – same

• Option buy premium - same

• ELM 4.25% becomes 2%

• Total decrease– 2.25%

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DRAFT

Margin examples - 4

• Long futures hedged with buy ATM put and short ATM call-Conversion Reversal• IM - no change (Nil)

• ELM 8.5% i.e. 4.25 FUT+ 4.25(short call) becomes 2 + 2 = 4%

• Min SOMC 5% becomes Nil

• Total decrease – 9.5%

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Margin examples - 5

• Bull Spread BUY ATM call sell OTM call• Initial Margin – Net premium paid - same

• Min SOMC 5% becomes Nil

• ELM 4.25% on short option becomes 2%

• Total decrease– 7.25%

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DRAFT

General impact

• Margins on all hedged Strategies will fall drastically

• Bull/Bear spread of 100 pts from 9.25% to 3%

• Calendar spread from 9.25% to 3.75%

• Ratio spread (1:2) from 18.5% to 13%

• 100 pt Butterfly Spreads from 18.5% to 5%

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DRAFT

Some useful hedging ideas

• Margins on futures are going up, if clients want to retainsame quantity they can reduce their margin and risk bybuying puts• Depending on preference client can buy ATM put or if he feels

premium is high he can buy some OTM put as per premium /riskprofile.

• Clients sometimes buy calls to express bullish view they cansell OTM calls based upon their price movement perception• Since margin on sell leg will be just 2% extra now as compared to

9% earlier

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DRAFT

Points to ponder – SPAN margins

• Entire execution systems are built around SPAN. If clientswant higher leverage they may need to execute two leggedtrades to remain within margin.• Either IOC or by asking client to buy first and sell later

• Same issue will arise at closing out of the position

• Overhaul of trading systems and RMS required

• Similar to current calendar spreads risks

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DRAFT

Points to ponder – liquidity

• Futures are daily settled and options are periodic

• Risk free positions can and will create cash flow issues

• Example• Long index Rs.1,00,00,000/-

• Have at the Money puts

• Markets collapse

• Futures loss pay-in to be made immediately (T + 1)

• Options profit pay-out only on expiry / selling (??)

• Mismatch

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DRAFTQ&A – Please type

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