margins the margining system is based on

8/14/2019 Margins the Margining System is Based On

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Margins

The margining system is based on the JR VermaCommittee recommendations. The actual margining

happens on a daily basis while online positionmonitoring is done on an intra-day basis.

Daily margining is of two types:

1. Initial margins

2. Mark-to-market profit/loss

The computation of initial margin on the futuresmarket is done using the concept ofValue-at-Risk(VaR). The initial margin amount is large enough tocover a one-day loss that can be encountered on 99%of the days. VaR methodology seeks to measure theamount of value that a portfolio may stand to losewithin a certain horizon time period (one day for the

clearing corporation) due to potential changes in theunderlying asset market price. Initial margin amountcomputed using VaR is collected up-front.

The daily settlement process called "mark-to-market"provides for collection of losses that havealready occurred (historic losses) whereas initial

margin seeks to safeguard against potential losses onoutstanding positions. The mark-to-market settlementis done in cash.


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Let us take a hypothetical trading activity of a client ofa NSE futures division to demonstrate the marginspayments that would occur.

A client purchases 200 units of FUTIDX NIFTY29JUN2001 at Rs 1500.

The initial margin payable as calculated by VaRis 15%.

Total long position = Rs 3,00,000 (200*1500)

Initial margin (15%) = Rs 45,000

Assuming that the contract will close on Day + 3 themark-to-market position will look as follows:

Position on Day 1

Close PriceLoss Marginreleased

Net cashoutflow

1400*200=2,80,000

20,000(3,00,000-2,80,000)

3,000(45,000-42,000)

17,000(20,000-3000)

Payment tobe made

(17,000)


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New position on Day 2

Value of new position = 1,400*200= 2,80,000

Margin = 42,000

Close PriceGain AddnMargin

Net cashinflow

1510*200=3,02,000

22,000(3,02,000-2,80,000)

3,300(45,300-42,000)

18,700(22,000-3300)

Payment tobe recd 18,700

Position on Day 3

Value of new position = 1510*200 = Rs 3,02,000

Margin = Rs 3,300

Close Price Gain Net cash inflow

1600*200=3,20,000

18,000(3,20,000-3,02,000)

18,000 + 45,300* =63,300

Payment tobe recd

63,300

Margin account*

Initial margin = Rs 45,000

Margin released (Day 1) = (-) Rs 3,000


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Position on Day 2 Rs 42,000

Addn margin = (+) Rs 3,300

Total margin in a/c Rs 45,300*

Net gain/loss

Day 1 (loss) = (Rs 17,000)

Day 2 Gain = Rs 18,700

Day 3 Gain = Rs 18,000

Total Gain = Rs 19,700

The client has made a profit of Rs 19,700 at the endof Day 3 and the total cash inflow at the close of tradeis Rs 63,300.


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Settlements

All trades in the futures market are cash settled on aT+1 basis and all positions (buy/sell) which are notclosed out will be marked-to-market. The closing priceof the index futures will be the daily settlement priceand the position will be carried to the next day at thesettlement price.

The most common way of liquidating an open position

is to execute an offsetting futures transaction bywhich the initial transaction is squared up. The initialbuyer liquidates his long position by selling identicalfutures contract.

In index futures the other way of settlement is cashsettled at the final settlement. At the end of the

contract period the difference between the contractvalue and closing index value is paid.

How to read the futures data sheet?

Understanding and deciphering the prices of futurestrade is the first challenge for anyone planning to

venture in futures trading. Economic dailies andexchange websites www.nseindia.com andwww.bseindia.com are some of the sources whereone can look for the daily quotes. Your website has a
http://www.nseindia.coma/http://www.bseindia.com/http://www.nseindia.coma/http://www.bseindia.com/


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daily market commentary, which carries end of dayderivatives summary alongwith the quotes.

The first step is start tracking the end of day prices.

Closing prices, Trading Volumes and Open Interestare the three primary data we carry with Index optionquotes. The most important parameter are the actualprices, the high, low, open, close, last traded pricesand the intra-day prices and to track them one has tohave access to real time prices.

The following table shows how futures data will begenerally displayed in the business papers daily.

ries FirstTrade

HighLow CloseVolume(No ofcontracts)

Value

(Rs inlakh)

No oftradesOpen

interes(No ofcontra

XJUN2000 4755 482047404783.1146 348.70 104 51XJUL2000 4900 490048004830.812 28.98 10 2

XAUG20004800 487048004835 2 4.84 2 1

tal 160 38252 116 54

Source: BSE

The first column explains the series that is beingtraded. For e.g. BSXJUN2000 stands for theJune Sensex futures contract.


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The column on volume indicates that (in case ofJune series) 146 contracts have been traded in104 trades.

One contract is equivalent to 50 times the price ofthe futures, which are traded. For e.g. In case ofthe June series above, the first trade at 4755represents one contract valued at 4755 x 50 i.e.Rs. 2,37,750/-.

Open interest indicates the total gross outstanding

open positions in the market for that particular series.For e.g. Open interest in the June series is 51contracts.

The most useful measure of market activity is Openinterest, which is also published by exchanges andused for technical analysis. Open interest indicatesthe liquidity of a market and is the total number of

contracts, which are still outstanding in a futuresmarket for a specified futures contract.

A futures contract is formed when a buyer and a sellertake opposite positions in a transaction. This meansthat the buyer goes long and the seller goes short.Open interest is calculated by looking at eitherthetotal number of outstanding long or short positions

not both.

Open interest is therefore a measure of contracts thathave notbeen matched and closed out. The number


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of open long contracts must equal exactly the numberof open short contracts.

Action Resulting openinterest

New buyer (long) and

new seller (short)Trade to form a newcontract.

Rise

Existing buyer sellsand existing sellerbuys The old contractis closed.

Fall

New buyer buys fromexisting buyer. TheExisting buyer closeshis position by sellingto new buyer.

No change there isno increase in longcontracts being held

Existing seller buysfrom new seller. The

Existing seller closeshis position by buyingfrom new seller.

No change there isno increase in short

contracts being held


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Open interest is also used in conjunction with othertechnical analysis chart patterns and indicators togauge market signals. The following chart may help

with these signals.

PriceOpen

interestMarket

Strong

Warningsignal

Weak

Warningsignal

The warning sign indicates that the Open interest isnot supporting the price direction.


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Glossary

Backwardation: A market where future prices ofdistant contract months are lower than the nearmonths.

Basis: The difference between the Index and therespective contract is the basis i.e. cash netted forthe Futures price. A negative basis means Futuresare at a premium to cash and vice versa. It is thestrengthening and weakening of basis that is trackedby market players i.e. whether the basis is wideningor narrowing. A widening of basis is indicative of

increasing longs and narrowing means increasingshort positions.

BasisPoint: It is equal to one hundredth of apercentage point


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Contango market:This is a market where futuresprices are higher for distant contracts than for nearbydelivery months.

Cost of carry:is an indicator of the demand-supplyforces in the Futures market. It basically means theannualized interest cost players decide to pay(receive) for buying (selling) a respective contract. Ahigher carry cost is indicative of buying pressure andvice versa. Carry Cost is a widely used parameter notonly because it is more interpretable being an

annualized figure, as compared to basis (Cash nettedfor Futures) but also because it works well with thetrio of Price, Volume and Open Interest in highlightingthe market trend.

Delivery month:Is the month in which delivery offutures contracts need to be made.

Delivery price:The price fixed by the clearinghouseat which deliveries on futures contracts are invoiced.

Also known as the expiry price or the settlement price.

Derivative:A financial instrument designed toreplicate an underlying security for the purpose oftransferring risk.


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Fair value:Theoretical value of a futures contractderived from a mathematical model of valuation.

Hedge Ratio:The Hedge Ratio is defined as thenumber of Futures contracts required to buy or sell so

as to provide the maximum offset of risk. Thisdepends on the

Value of a Futures contract; Value of the portfolio to be Hedged; and Sensitivity of the movement of the portfolio price

to that of the Index (Called Beta).

The Hedge Ratio is closely linked to the correlationbetween the asset (portfolio of shares) to be hedgedand underlying (index) from which Future is derived.

Initial margin:The money a customer needs to payas deposit to establish a position in the futures


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market. The basic aim of Initial margin is to cover thelargest potential loss in one day.

Mark-to-market:The daily revaluation of open

positions to reflect profits and losses based on closingmarket prices at the end of the trading day.

Forward contract: In a forward contract, two partiesagree to do a trade at some future date, at a statedprice and quantity. No money changes hands at thetime the deal is signed.


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Futures contract:A futures contract is similar to aforward contract in terms of its working. Thedifference is that contracts are standardized andtrading is centralized. Futures markets are highlyliquid and there is no counterparty risk due to thepresence of a clearinghouse, which becomes the

counterparty to both sides of each transaction andguarantees the trade.

Far contract:The future that is furthest from itsdelivery month i. e. has the longest maturity.

Speculation:Trading on anticipated price changes,where the trader does not hold another position which

will offset any such price movements.

Spread ratio:The number of futures contractsbought, divided by the number of futures contractssold.

VaR:Value at Risk. A risk management methodology,which attempts to measure the maximum loss

possible on a particular position, with a specified levelof certainty or confidence.


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Strike Price:The price at which an option holder maybuy or sell the underlying asset, which is specified inan option contract


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Glossary

Backwardation: A market where future prices of distant contract months are lower than thenear months.

Basis: The difference between the Index and the respective contract is the basis i.e. cash

netted for the Futures price. A negative basis means Futures are at a premium to cash andvice versa. It is the strengthening and weakening of basis that is tracked by market playersi.e. whether the basis is widening or narrowing. A widening of basis is indicative of increasinglongs and narrowing means increasing short positions.

BasisPoint: It is equal to one hundredth of a percentage point

Contango market:This is a market where futures prices are higher for distant contracts thanfor nearby delivery months.

Cost of carry:is an indicator of the demand-supply forces in the Futures market. It basicallymeans the annualized interest cost players decide to pay (receive) for buying (selling) arespective contract. A higher carry cost is indicative of buying pressure and vice versa. CarryCost is a widely used parameter not only because it is more interpretable being an annualized

figure, as compared to basis (Cash netted for Futures) but also because it works wellwith the trio of Price, Volume and Open Interest inhighlighting the market trend.

Delivery month:Is the month in which delivery offutures contracts need to be made.

Delivery price:The price fixed by theclearinghouse at which deliveries on futurescontracts are invoiced. Also known as the expiryprice or the settlement price.

Derivative:A financial instrument designed toreplicate an underlying security for the purpose oftransferring risk.

Fair value:Theoretical value of a futures contractderived from a mathematical model of valuation.

Hedge Ratio:The Hedge Ratio is defined as thenumber of Futures contracts required to buy or sellso as to provide the maximum offset of risk. This


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Hedging

Stock index futures contracts offer investors, portfoliomanagers, mutual funds etc several ways to control

risk. The total risk is measured by the variance orstandard deviation of its return distribution. A commonmeasure of a stock market risk is the stocks Beta.The Beta of stocks are available on thewww.nseindia.com.

While hedging the cash position one needs to

determine the number of futures contracts to beentered to reduce the risk to the minimum.

Have you ever felt that a stock was intrinsicallyundervalued? That the profits and the quality of thecompany made it worth a lot more as compared withwhat the market thinks?

Have you ever been a stockpicker and carefullypurchased a stock based on a sense that it was worthmore than the market price?

A person who feels like this takes a long position onthe cash market. When doing this, he faces two kindsof risks:

1. His understanding can be wrong, and the companyis really not worth more than the market price or

2. The entire market moves against him andgenerates losses even though the underlying ideawas correct.


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If the index is at 1200 * 200 (market lot) = Rs 2,40,000

The number of contracts to be sold is:

a. 1.19*10 crore = 496 contracts

2,40,000

If you sell more than 496 contracts you areoverhedged and sell less than 496 contracts you areunderhedged.

Thus, we have seen how one can hedge theirportfolio against market risk.


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A portfolio manager owns three stocks

Stock Beta No. of shares Stock price(Rs)

A 1.1 100000 400

B 1.2 200000 300

C 1.3 300000 100

The spot Nifty index is 4400 and the futures price is 4450

The stock index futures can be used to

a. decrease portfolio beta to 0.8b. increase portfolio beta to 1.5

Current Beta of stock portfolio

Stock Value of invest. Fraction of portfolio Wi * Bi

A 4 Crores 4/13 0.3077 * 1.1

B 6 Crores 6/13 0.4615 * 1.2

C 3 Crores 3/13 0.2308 * 1.3

13 Crores Wi = 1.00 1.19


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To decrease portfolio beta from 1.19 to 0.8, the portfolio

manager can sell off a portion of equity portfolio and use

the proceeds to buy riskless securities.

Bp = A1B1 + A2B2

0.8 = A1 * 1.19 + ( 1-A1) * 0

A1 = 0.672269

Equity portion in portfolio = 0.672269 * 13 Crores

= 8.7395 crores

Value of portfolio to be hedged = 13 crores - 8.7395 crores

= 4.2605 crores

Hedge Ratio ( HR ) = 1.19 * 4.2605 crores

4400

= 11523 nifty contracts= 11523 / 50= 230 lots of 50 each.


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b) Increase the portfolio beta to 1.5

1.5 = A1(1.19) + (1-A1)0

A1 = 1.2605

(1 1.2605) * 13 Crores = 3.3865 Cr needs to beborrowed and invested.

Alternatively, the portfolio manager can buy an

equivalent amount of stock index futuresi.e 3.3865 * 1.19 = 4.03 crores

Hedge Ratio = 3.3865 cr * 1.194400

= 9159 contracts= 9159/50= 183 lots of 50 contracts each.

Alternatively the following formula can be used

No. of futures

contracts reqd =Total portfolio value * ( Desired Beta existing Beta)

Value of underlying Spot Index


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a) beta = 0.8

No. of futures

contracts reqd = 13 Cr * ( 0.8 1.19)4400 * 50

= - 230 lots of 50 each ( Short sell )

b) beta = 1.5

No. of futures

contracts reqd = 13 Cr * ( 1.5 - 1.19)4400 * 50

= 183 lots of 50 contracts each.( Long )

2) An equity fund manager owns a portfolio of Rs.10crore in stocks with a portfolio beta of 1.15. He isconcerned that stock prices will fall in the next fewdays. But he does not wish to bear the brokeragecosts and the price pressure of selling stocks andthen buying them again after the anticipated decline.

Assuming an underlying spot price of Nifty futures at4200 and futures at 4500, he decides to use futures tohedge against the expected market decline.

What is the risk minimising hedge for the stockposition if the fund manager desires a portfolio beta ofa) 0.7 b) 0.5


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margins the margining system is based on

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