Last Updated on May 25, 2022 by Neera Bhardwaj
When a person is buying or selling any futures or options, their broker collects something called a margin. This margin’s motive on contracts is to provide a cover against the viable risk of adverse price movements. Generally, there are two broad types of margins: the SPAN margin and the exposure margin.
SPAN and exposure margins are each tool of risk analysis. While the SPAN margin is the minimum requisite blocked future and option writing positions under the exchanges’ mandate, exposure margins are blocked after the SPAN cushion for any viable ATM losses. You are required to pay the initial or total margin at the time of entering a position. The sum of SPAN and exposure margin makes up the total margin. In this article, we will explore what is a SPAN and exposure margin, and dive deep into the important pointers of each of these functions.
Table of Contents
What is SPAN margin?
SPAN or Standard Portfolio Analysis of Risk is a technique that derives its name from the software program used to calculate it and is employed to measure portfolio risk. Also normally referred to as a VaR margin in Indian stock markets, the SPAN margin is the minimum margin requirement to initiate a trade in the market. It is calculated through a standardized form of portfolio analysis of risk for F&O strategies. By using certain tools, one can calculate their margin from multiple positions before they go ahead and place their order. Usually, the SPAN margin is employed by those who are F&O traders who already have sufficient cover from their positions to cover any potential losses.
The general rule of thumb: the lower the volatility, the lower the Standard Portfolio Analysis of Risk (SPAN). And the higher the volatility, the higher the SPAN requirement. Click To Tweet
The way the SPAN margin functions, for each position in a portfolio, the margin is set via the system to account for the possibility of the worst intraday movement. This is carried out through a calculation of an array of risk factors to ascertain the potential gains and losses for a contract under varied conditions. Some of the aforementioned conditions consist of volatility, changes in price as well as a decrease in the deadline.
SPAN margins differ from security to security depending on the nature of risk that one has to take on along with the security. For instance, the SPAN margin requirement for a single stock will be higher than the requirement for an Index. This is because the risk involved in an individual stock is higher than the risk in an Index. Furthermore, a general rule of thumb is that, the lower the volatility, the lower the SPAN, and subsequently, the higher the volatility, the higher the SPAN requirement.
What is exposure margin?
The exposure margin is charged over and above the SPAN margin and is typically carried out at the discretion of the broker. Also known as an additional margin, it is collected to protect against a broker’s liability that can also potentially arise due to erratic swings in the market. One way to look at the SPAN and exposure margins is that the SPAN margin is an initial calculation derived from assessing the risk and volatility factors. On the other hand, the exposure margin is comparable to an add-on margin value that is dependent on the exposure that one undergoes.
While calculating exposure margins, the underlying rule is that the margin for index futures contracts is limited to 3% of the total value of the contract. For example, if a Nifty future contract was valued at Rs 10 lakh, the exposure margin would be 3% of the value, or Rs 30,000.
At the time of initiating a futures trade, the investor has to adhere to the initial margin. Put simply, this is what is derived as soon as the SPAN and exposure margins are combined. Once confirmed, the entire margin is blocked by the exchanges. As per new guidelines enforced in 2018, each margin has to be blocked for an overnight position. Failure to adhere to this results in a penalty being imposed.
How is the exposure margin calculated?
For index futures, exposure margins are usually 3% of the entire value of the contract. The calculation would be like this: should the value of the Nifty contract be worth Rs 4 lakh, the exposure margin would be 3%. That amounts to Rs 12,000. This is for Nifty futures. For stocks, derivatives, and options, the exposure margin is usually 5% or 1.5 times the standard deviation, whichever is higher.Standard Portfolio Analysis of Risk (SPAN) margin cushions products from the volatility of the market. Click To Tweet
How to calculate the SPAN margin?
The SPAN margin calculation methodology is:
Step 1: One has to select the exchange on which the trading needs to be done
Step 2: Now the product has to be selected, it could either be Futures or Options
Step 3: The ticker symbol on the scrip, which you wish to trade, has to be selected
Step 4: Now the type of trade needs to be selected. It either has to be put or call
Step 5: The expiry date of the trade is important information that now needs to be selected
Step 6: In case you have selected options, the strike price has to be selected
Step 7: Now the lot size of your trade needs to be entered
Step 8: You are all set for your SPAN calculation
The automated system will do the math for you and display the margin amount you need to be prepared for.
We have, in the course of the article, covered the details of SPAN margin and how it helps cushion products from the volatility of the market. It is primarily a tool to guard portfolios and their positions against wild price changes. It, along with the exposure margin which forms the second layer of protection, is a perfect way to secure oneself from untold losses in the market.