Guide on Margin: Cash vs. Derivatives Markets and Cross-Margining

This guide eliminates confusion about margin concepts, covering cash and derivatives markets, cross-margining, and the use of the AlgoTest Margin Calculator. It is an essential resource for traders seeking clarity and efficiency in managing their trading margins.

1. What is Margin?

Definition:

Margin is the amount traders must maintain with their brokers to initiate and sustain positions. It ensures sufficient coverage for potential risks in both cash and derivatives markets.

2. Margin in Cash Markets

Definition:

The cash market, or spot market, is where financial instruments are traded and settled instantly, but delivery is settled on T+2 days.

Margin in Cash Markets:

Margins are simpler in the cash market compared to derivatives. They primarily secure intraday trades and large holdings.

Key Components:

1. Initial Margin:
   A percentage of the transaction value required upfront.
2. Value at Risk (VaR) Margin:
   Based on historical price volatility of the stock.
3. Extreme Loss Margin (ELM):
   Additional margin to safeguard against extreme market scenarios.

Collateral Use:

Investors can pledge shares or securities held in Demat accounts to secure margins for trading.

Use Cases:

• Ideal for intraday trading or margin funding for quick trades.
• Example: A trader buying stocks worth ₹1,00,000 may only need an initial margin of ₹20,000, depending on broker and stock regulations.

3. Margin in Derivatives Markets

Definition:

Derivatives markets deal with contracts like futures and options whose values derive from underlying assets (e.g., stocks, indices, commodities). Learn more about this here.

Margin in Derivatives Markets:

Margins in derivatives cover the higher risks associated with leverage.

Key Components:

1. SPAN Margin:
   • A base margin calculated using risk scenarios defined by SPAN (Standard Portfolio Analysis of Risk).
   • Accounts for portfolio-level risks.
2. Exposure Margin:
   • An additional buffer to cover unforeseen volatility.
3. Premium Margin (For Options Buyers):
   • Full premium amount is collected upfront for options contracts.
4. Mark-to-Market (MTM) Margin:
   • Daily adjustments based on profit/loss due to changes in contract value.

Collateral Use:

Traders can pledge securities or cash to meet SPAN and exposure margin requirements.

Use Cases:

• Suitable for hedgers, speculators, and arbitrageurs.
• Example: A trader holding a Nifty futures contract must maintain both SPAN and exposure margins, which vary daily based on MTM settlements.

4. What is Cross-Margining?

Definition:

Cross-margining allows margin offsetting between positions in different market segments (e.g., cash and derivatives) and instruments with the same underlying asset.

How It Works:

• Applies to hedged positions such as futures vs. options on the same underlying.
• Encourages capital efficiency by reducing the overall margin requirement.

Key Examples:

• Futures vs. Futures: Margins are offset when holding hedged positions like long and short futures contracts.
• Cash vs. Futures: Rarely available to retail clients, requiring regulatory approval.

History of Cross-Margining:

Introduced by NSE, inspired by CME’s cross-margining framework.

Benefits:

1. Capital Efficiency: Lower margin requirements for hedged portfolios.
2. Enhanced Liquidity: Encourages more participation in the markets.
3. Risk Mitigation: Ensures efficient allocation of funds while managing exposure.

5. SPAN Margin and SPAN Exposure

SPAN Margin:

• A mandatory margin calculated using advanced risk scenarios (e.g., price movements, volatility).
• Ensures portfolio-level risk is covered.

SPAN Exposure or ELM (Extreme Loss Margin):

• An additional layer of risk management applied over SPAN Margin for high-volatility scenarios.

Example:

A trader holding hedged positions in Nifty futures and options will benefit from reduced SPAN margin requirements due to the offsetting risk.

6. Collateral and Pledging

Collateral:

Securities pledged by traders to secure margins.

Pledging:

The process of transferring rights of collateral to brokers for trading limits.

• In Cash Markets: Shares in Demat accounts can be pledged to secure intraday margins.
• In Derivatives Markets: Pledged collateral must meet strict regulatory requirements for SPAN and exposure margins.

7. NSE India Margin Framework

• Detailed guidelines for margins are available under NSE’s Risk Management section.
• Official resource: Equity Market Cross-Margining.

FAQs

1. What is the purpose of SPAN Margin?
   It ensures traders maintain sufficient risk coverage for multiple market scenarios.

2. How is margin different in cash vs. derivatives markets?
   FnO markets have simpler, lower margins compared to the complex, higher margins in cash.

3. Can I benefit from cross-margining as a retail trader?
   Yes, if you hold hedged positions with the same underlying asset. But ONLY if your broker provides it.

4. What happens if I don’t meet margin requirements?
   Your broker may square off your position or demand additional funds.

5. How does AlgoTest’s Margin Calculator help?
   It simplifies SPAN and exposure calculations, allowing traders to plan effectively.

Using AlgoTest’s Margin Calculator

How It Works:

1. Input the trade details.
2. View margin requirements for derivatives markets (and Cash is coming soon).
3. Check potential benefits of cross-margining.

Benefits:

• Accurate margin estimations.
• Simplified trading for both beginners and professionals.