What is Mark to Market?
Are you aware of what is Mark to market? Initially, when you are starting in the futures and options you must have the question in mind - what is Mark to market?
Mark to Market, also known as MTM, is a stock market term applicable in futures and options. Mark to market means when the underlying asset values at the end of the day are determined following the market prices. Mark to market margin is bound to find if there is a loss or profit to the parties involved.
The mark to market margin considers the current market situations that affect the company's overall performance. And with the mark to market calculation, the investors can find out the current fair value of the company's financial position.
The price of assets and liabilities change, and the mark to market margin method is useful when an investor needs to find the current fair value of them.
Now you have the answer of what is mark to market, let us know its meaning in futures.
Mark to market margin in futures
Mostly the margin mark to market is used in futures. So mark to market margin in futures needs to consider the prices of the contracts that fluctuate every day. These fluctuations either lead to profit or losses to the buyers and sellers. So here, the mark to market margin in futures helps out by settling Initial Margin for these profits or losses.
In Initial Margin, two margins are included. These two margins in mark to market margin are;
1) SPAN Margin and 2) Exposure Margin.
Standard Portfolio Analysis of Risk or SPAN Margin considers the VAR (Value at Risk) based on the assessment done globally over the risk of one day. SPAN Margin takes into consideration risk arrays and risk scenarios (modeled). SPAN Margin is specified by the exchange. The collection of the SPAN Margin is when the trade is initiated. The calculation of this margin is based on both volatility and risk. SPAN Margin changes with time because it considers the volatility.
Exposure Margin is the additional margin that is collected over the previously briefed SPAN Margin. Exposure Margin is also considered as an Ad Hoc Margin that is obtained by the calculation of the exposure the investors take. Exposure Margin stays the same. This is because Exposure Margin is only there to provide additional safety.
So, the Initial Margin = SPAN Margin + Exposure Margin.
Mark to market calculation
Now you know about the MTM, so you should also know about the mark to market calculation. The mark to market calculation is very important because it shows the amount of profit or loss you have incurred over a specific period.
The mark to market calculation follows three major steps. First, the MTM calculation for finding out the profit or loss. The profit and loss consider the MTM calculation is for Positions MTM, and it subtracts it from the Transaction MTM.
All of the MTM calculations are given below.
Position MTM = (Current Closing Price - Previous Closing Price) x Previous Quantity x Multiplier
Transaction MTM = (Current Closing Price - Previous Closing Price) x Current Quantity x Multiplier
And After you obtain both of the values, you need to follow the below formula,
MTM Profit/Loss = Position MTM - Transaction MTM - Commission
So these were the MTM calculations.
Mark to Market in derivatives
The mark to market in derivatives is useful for futures contracts. The mark to market in derivatives considers the value of the security during the trading day.
If its value increases, then the buyer who has bought the long position gets profit money. This money collected is equal to the change in the value of the security. This value change is equal to value change in security.
Enough the securities value decreases to collect the money from the buyer of security. This value change is equal to the value change in security.
Let us understand the market in derivatives with an example.
ABC Company holds two different passive stocks A1 and A2. The price of A1 stock is 50 rupees per share, whereas the price of A2 stock is around 250 rupees per share. This price is given for a single day. A1 stock is considered available for sale, where A2 stock is considered for trading.
So let's say at the end of the day, the price of stock A1 is around 70 rupees, and the price of stock A2 is around 210 rupees. Here we can see that stock A has an increase of 20 rupees per share, and stock A2 has a decrease of 40 rupees per share. Stock A1 - available for sale here will be considered in other comprehensive income in the balance sheet of the company's equity section. And the trading stock A2 here will be considered in marketable securities in the company's balance sheet accounts side. A2 is as a result of this the unrealized loss of the company.
So this is how mark to market in derivatives or financial derivatives works.
The mark to the market calculation for options is not possible because the market is only considered for futures contracts and not options. Also, the mark to market calculation for options is not possible because this calculation is a daily cash settlement calculation.
The calculations of profit and loss depend upon different situations such as intraday trade.
But there is one way for the mark to market calculation for options, which is as below. In options, the buyer can choose if he wants to exercise the contract he has or not on the expiry. If the buyer is earning a profit, he would not prefer to exercise it.
The mark to market calculation for options applies to the premium. With the change in the price of the scrip, the change in the premium amount will happen.
To calculate MTM for options, let us understand a simple example,
If you buy the Long contract total number of 200 at 20 INR, The premium amount considered here is at 20 INR. So the total amount of premium you pay is 4000 INR (200x20). But if your profit decreases with the amount of premium decrease, you have incurred losses. If your LTP (Last Traded Price) is 14 INR and MTM profit is 2,800 INR, then the calculations will be like the below,
Value of LTP here is, 200*14 = 2,800
Total investment calculation = 20*200 = 4,000
So, the total loss of premium is around Rs. 1200 (4000-2800)
So, the above was the calculation of MTM in options.
MTM is calculated to find the daily profit and loss in the futures. MTM closely follows the market price, and based on that, the value of underlying assets is determined.