Financial Daily from THE HINDU group of publications
Sunday, Aug 11, 2002
Financial Daily from THE HINDU group of publications Sunday, Aug 11, 2002 |
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Investment World
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Derivatives Markets Markets - Derivatives Markets Columns - Simple Economics What is cross-margin? B. Venkatesh
A NEWS report stated that the Securities and Exchange Board of India (SEBI) is considering cross-margins between the spot and derivatives segment. What is cross-margin? In the futures market, you do not pay the entire amount for buying a contract. Suppose Satyam futures is trading at Rs 235, you may have to pay just 25 per cent of that amount, which is referred to as margin. The contract is then marked-to-market. Thus, if Satyam moves to Rs 230 the next day, you will have to pay Rs 5 (Rs 230-235) to your broker, who will pass on the money to the seller's broker. Note that the seller of the futures contract will also deposit 25 per cent of Rs 235 as her margin. Such margin money is collected so that the trading in Satyam futures is not affected even if the buyer/seller defaults on the contract. A default can occur, for instance, if Satyam goes down to Rs 220 and you refuse to pay the marked-to-market margin of Rs 15 (Rs 220-235) to your broker. In such cases, your broker will sell your futures contract, and use the proceeds to settle the transaction. The margin money that he collected from you helps in the settlement process. Now, the cross margining refers to a position where the margin requirements in the derivatives market will reduce if you hold stock in the spot market. Suppose you hold ten shares of Satyam stock. If you default on your futures position, the broker can sell your Satyam stock and use the proceeds to close your position in the futures contract. As this safeguards the trading system from buyer/seller defaults, the margin you will have to pay on your futures position can be lower. This is what is referred to as cross margining.
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