You’re ready to embark on an exciting journey in the stock market, hoping to reap profits. However, you might encounter a margin call, leaving you puzzled about your trading position. Brokers often request additional funds while trading derivatives due to margin requirements. Two critical margins every trader should know about are SPAN Margin and Exposure Margin. These are vital for safeguarding traders and maintaining market stability, especially in volatile conditions. Grasping these concepts will empower you to manage your trades more effectively.
What Does Margin Trading Mean?
Margin trading allows investors to borrow funds from brokers to trade securities while using their existing investments as collateral. This strategy enables traders to buy more securities than their available cash would permit, potentially increasing returns—but also amplifying risks.
When you engage in margin trading, you open a margin account. Unlike a standard brokerage account, this one lets you borrow money to invest in more securities. The borrowing limit is determined by the margin requirement, which indicates the percentage of the total purchase price you need to cover with your own funds. For example, if the margin requirement is 50%, you can borrow up to half the cost of the securities.
Example: If you wish to purchase stocks worth ₹1,00,000 but have only ₹50,000, you can borrow the remaining ₹50,000 from your broker using a margin trading facility (MTF). If the stock value increases to ₹1,20,000, you can sell them, repay the ₹50,000 loan, and pocket the profit, excluding any interest or fees. However, if the stock value falls to ₹80,000, you’ll still owe ₹50,000 to the broker, leading to a considerable loss.
SPAN Margin Explained
SPAN (Standard Portfolio Analysis of Risk) Margin assesses the overall risk of a trader’s portfolio by estimating potential losses in a single day. It utilizes advanced algorithms, considering factors like asset price, volatility, time to expiration, and risk-free interest rate. SPAN ensures traders maintain sufficient margins to cover potential losses, thereby preserving market integrity.
SPAN Margin in Different Scenarios
Scenario 1: Nifty Futures Contract
If you hold a Nifty futures contract worth ₹25,00,000 and the SPAN margin requirement is 10%, the calculation would be:
SPAN Margin = Contract Value × SPAN Margin Percentage
= ₹25,00,000 × 0.10
= ₹2,50,000
You must maintain ₹2,50,000 as margin for this position.
Scenario 2: Bank Nifty Call Options
For selling Bank Nifty call options with a strike price of ₹35,000 and a premium of ₹500, if the SPAN margin requirement is 15%, the calculation is:
Notional Value = Strike Price × Lot Size
Assume the lot size is 25:
Notional Value = ₹35,000 × 25 = ₹8,75,000
SPAN Margin = ₹8,75,000 × 0.15 = ₹1,31,250
You need ₹1,31,250 to maintain this position.
Scenario 3: Multi-Leg Options Strategy
In a bull call spread strategy, if the SPAN margin for the bought call is ₹20,000 and for the sold call is ₹25,000:
Net SPAN Margin = SPAN Margin (Bought Call) + SPAN Margin (Sold Call)
= ₹20,000 + ₹25,000 = ₹45,000
The margin required here is ₹45,000.
What is Exposure Margin?
Exposure Margin accounts for a trader’s overall exposure to market risks by analyzing portfolio volatility and asset correlations. Portfolios with more volatile assets require higher exposure margins.
Exposure Margin in Various Scenarios
Scenario 1: Index Futures and Options
For index futures and options, Exposure Margin is typically a percentage of the contract value. For example, if the contract value is ₹10,00,000 and the margin percentage is 2%, the required margin is:
Exposure Margin = ₹10,00,000 × 0.02 = ₹20,000
Scenario 2: Stock Futures and Options
Due to higher volatility, stock futures and options often demand a higher margin. For a contract value of ₹5,00,000 with a margin rate of 3.5%, the calculation is:
Exposure Margin = ₹5,00,000 × 0.035 = ₹17,500
Scenario 3: Intraday Trading
In intraday trading, margins are based on trade value and asset volatility. For a high-volatility stock worth ₹2,00,000, with a 5% margin requirement:
Exposure Margin = ₹2,00,000 × 0.05 = ₹10,000
Scenario 4: Delivery Trades
For delivery trades where positions are held overnight, higher margins are required. For stocks worth ₹3,00,000 with a 4% margin:
Exposure Margin = ₹3,00,000 × 0.04 = ₹12,000
What is a Margin Call?
A margin call arises when your account’s equity drops below the broker’s minimum requirement. This requires you to either add funds or sell assets to meet the margin.
Example: If you purchase shares worth ₹1,00,000 with ₹50,000 of your own money and ₹50,000 borrowed, and the stock value falls to ₹70,000, your equity reduces to ₹20,000 (₹70,000 – ₹50,000). If the maintenance margin is 25%, you need equity of ₹17,500 (25% of ₹70,000). Falling below this threshold triggers a margin call.
Final Thoughts
Grasping SPAN and Exposure Margins is essential for managing risks in derivatives trading. These margins protect traders and ensure market stability. SPAN Margin evaluates portfolio risk, while Exposure Margin accounts for volatility. By understanding these concepts, you can handle trades more effectively and reduce surprises like margin calls.
To embark on margin trading, open a Demat Account Online through a reliable platform. Consider starting an SIP to diversify your investments and steadily grow your portfolio.
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