There is a system in the stock market that if a trader wants to buy or sell a futures contract then he has to pay the initial margin to the broker. The motive behind collecting this margin amount upfront is to cover the risk of adverse price movements. Implementation of the margin system ensures that each trader is serious about the buying and selling of trades and is bound to the obligations.
Mainly there are two types of margins charged by the brokers: Span margin & Exposure Margin.
For traders, it is necessary to pay the Initial or total margin while entering a position. The total or initial margin is nothing but the sum of SPAN margin and exposure margin.
Initial Margin (Total Margin) = SPAN Margin + Exposure Margin
The stock exchange defines the SPAN and Exposure margins depending upon the nature of security. These margins are the tools of risk analysis. In this blog, we have discussed everything about SPAN and exposure margin.
What is the span margin?
The minimum necessary margin amount collected by the stock exchange before writing F and O (futures and option) positions is called SPAN margin. It is the indemnity amount reserved to cover losses against possible adverse price movements. SPAN is the minimum margin requirement needed to transact a futures or options trade in the stock market. The margins are made mandatory as they represent the calculated portfolio risk.
The SPAN margin of any contract is calculated by software named Standardized Portfolio Analysis of Risk (SPAN) for F & O strategies while trading commodities, equities, and currencies. It is also known as VaR (Value at Risk) and it is the minimum margin required to initiate a trade in the market. SPAN margin calculator is used mainly by F & O (Futures and Options) traders.
SPAN margins are different for different securities depending on the type of risk with that security. For example, the SPAN margin requirement for a single stock will be higher than that for an Index in view of the risk that the portfolio might be higher than an Index.
Always remember 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.
How is the SPAN margin calculated?
There are many SPAN margin calculator tools available in the market to help you calculate SPAN margin requirements, but the SPAN margin remains the same for intraday as well as overnight trade. Many times brokers may offer lower upfront charges as incentives due to the lower risk factor.
The SPAN calculator tools are standardized under The Standardized Portfolio Analysis of Risk (SPAN) system which is implemented by many exchanges. The margin requirement is calculated based on a one-day risk of a trader's account. The system calculates the maximum possible one-day loss of an account based on different possible market scenarios. The maximum loss of the calculated scenarios is the margin requirement.
The probable premium value at each price scan point is calculated by SPAN in the upward volatility and downward volatility scenario. These probable premium values are then compared to the theoretical premium value (based on the last closing value of the underlying) to determine profit or loss.
SPAN decides the margin requirements based on a global evaluation of the one-day risk for a trader's account. Calculation of SPAN margin is done by using risk arrays and modeled risk scenarios that are processed and analyzed by sophisticated algorithms.
What is the Exposure margin?
The margin which is charged over and above the SPAN margin to cushion any MTM (Mark to Market) losses is called the Exposure margin.
At the time of taking any position the stock exchange blocks the initial margin which is the sum of SPAN margin and exposure margin. Therefore the margin ( an additional margin over and above the SPAN margin) which is collected in addition to the SPAN margin at the time of taking the position is known as the Exposure margin and is also known as the additional margin.
This margin is collected to provide protection against a broker’s responsibility that may potentially arise due to unpredictable swings in the market. At the time of initiating a futures trade, the investor has to complete the initial margin requirement.
How to calculate exposure margin?
The Exposure margin charged for index futures contracts is 3% of the value of the contract. For example, if the value of a NIFTY futures contract is Rs.7,00,000 then the Exposure margin applicable on this future contract will be 3% of Rs. 7,00,000 i.e. Rs. 21,000.
The Exposure margin charged for Stocks, options, and other derivatives, is usually 5% or 1.5 times the Standard deviation, whichever is higher.
When SPAN and Exposure margins are collected?
As discussed above the exposure margin is not paid separately instead it gets summed up in the total margin requirements.
As the risk of intraday trades is lower than overnight / carry forward trades brokers charge only a percentage of the total margins for Intraday trades.
As per new guidelines imposed in 2018, both SPAN and Exposure margins have to be blocked for an overnight position. If one fails to comply with these rules penalty will get imposed on that personnel.
What is the difference between Exposure Margin and SPAN Margin?
The SPAN margin is calculated initially based on the risk assessment and volatility factors. Whereas the exposure margin is an additional margin value that is dependent on one’s risk exposure.
As per the underlying rule, the exposure margin for index futures contracts is limited to 3% of the total value of the contract while the SPAN margin is an initial margin that is calculated on the basis of the risk and volatility of the underlying.
The SPAN margin for a particular security is not constant all the time. It keeps changing from time to time based on the volatility of the underlying whereas the Exposure margin won’t change as its basic function is to work as an additional safety net.
Which are the segments where SPAN and Exposure margin are applicable?
Exposure margins are applicable for trading in the NSE (National Stock Exchange) in the F&O (Futures and Options) segments and trading in the MCX (Multi Commodity Exchange) in the commodity derivatives.
The Span margin of a contract is calculated for F&O (Futures and Options) strategies at the time of trading equities, commodities, and currencies.
This way we have covered the details of SPAN and exposure margin in this blog and get to know how this margin helps cushion products from the uncertainties of the market.In order to cover any potential future loss, futures and options traders should maintain a sufficient margin in their accounts. The SPAN margin and exposure margins are the two values used by writers to maintain this margin. The total initial margin is calculated by using the values of SPAN and Exposure margin i.e. Total Margin = SPAN Margin + Exposure Margin.