When an individual is buying or selling any futures or options, their broker collects something known as Margin. This margin’s purpose on contracts is to provide a cover against the potential risk of adverse price movements. Generally, there are two broad types of margins: The SPAN margin and exposure margin.
Span and exposure margins are both tools of risk analysis. While the SPAN margin is the minimum requisite blocked future and option writing positions in accordance with the exchanges mandate, exposure margins are blocked after the SPAN cushion for any potential atm losses. In this article, we will explore what is a SPAN and exposure margin, and look into the details of each of them functions.
SPAN, or Standard Portfolio Analysis of Risk is a method that derives its name from the software used to calculate it (SPAN) and is employed to measure portfolio risk. Also commonly referred to as a VaR margin in indian stock markets, the SPAN margin is the minimum margin requirement in order to initiate a trade in the market. It is calculated by a standardized form of portfolio analysis of risk for F&O strategies. By employing 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 ample cover from their margin to cover any potential losses.
The way the SPAN margin functions, for every position in a portfolio, the margin is set by the system to account for the possibility of the worst intraday movement. This is achieved through a calculation of an array of risk factors that are in charge of ascertaining the potential gains and losses for a contract under an array of conditions.Some of the aforementioned conditions include volatility, changes in price as well as a decrease in the deadline.
SPAN margins vary 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 due to the risk of the portfolio being higher than an Index. Furthermore, a general rule of thumb followed is the lower the volatility the lower the SPAN and subsequently higher the volatility, higher the SPAN requirement.
There are several calculator tools created by companies to help you calculate SPAN margin requirements, but the SPAN margin remains the same regardless of whether the nature of the trade is an intraday or overnight trade. Oftentimes, brokers may choose to offer lower upfront charges as incentive due to the risk factor being lower.
The exposure margin is charged over and above the SPAN margin, and is usually done so at the discretion of the broker. Also known as an additional margin, it is collected in order to provide protection against a broker’s liability that may 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 one undergoes. While the SPAN margin varies from
While calculating exposure margins, the underlying rule is that the margin for index future contracts is limited to 3% of the total value of the contract. For example, if a NIFTY future contract was valued at 1,000,000, the exposure margin would be 3% of the value, or 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 once the SPAN and exposure margins are combined. Once confirmed, the entire margin is blocked by the exchanges. As per new guidelines enforced in 2018, both margins have to be blocked for an overnight position. Failure to adhere to this results in a penalty being imposed.
In order to cover any potential future loss, writers of options and futures maintain a sufficient margin in their accounts. The SPAN margin and exposure margins are the two broad entities used by writers in order to maintain this margin.
The SPAN and exposure margins are used to calculate the total margin. The total margin is a sum of the SPAN and exposure margins. While the SPAN margin varies based on the future and options, the exposure margin likely to remain more or less at the same level. However, brokers might be motivated to drop exposure margins as incentive for potential customers.