Stocks

F&O margin: Pay more for volatile stocks; using options to cost less

PALAK SHAH Mumbai | Updated on February 25, 2020 Published on February 25, 2020

Higher volatility in stocks will now call for higher margin requirement in both cash and for naked positions in derivative segment, according to SEBI’s new norms announced on Monday. But there is a huge relief for those who want to hedge their positions using options strategy, where the margin requirement falls by almost 70 per cent, according to the new rules. This could largely help algorithmic players who form large part of liquidity pool in the market and participate in futures and options (F&O) strategies.

Since the requirement of margin will rise with volatility in stocks, experts say the new norms have switched to 6-sigma risk management, the toughest, compared to the earlier 3.5-sigma in the cash and derivative segments.

“For securities with intra-day price movements of more than 10 per cent in the underlying (cash) market for three or more days in the past one month, the minimum total margins shall be equal to the maximum intra-day price movement of the security observed in the underlying market in last one month,” SEBI said. This would be continued till monthly expiry date of derivative contracts that falls after completion of three months from date of levy.

Simply put, the margin requirement will rise with increase in volatility in stocks. For instance, if 5 per cent margin was required earlier, it could rise to 7 per cent if volatility in stocks spikes up. In the cash segment, brokers collect upfront margin for intra-day trades or where high frequency orders are specified as intra-day trades.

“The new margin method is based on actual risk and is more scientific. The norms say, higher the risk, higher the margin,” said Rajesh Baheti, MD, Corsseas Capital.

“Option strategies with the new lower margins will make business sense for all traders. This should hopefully get a new breed of traders to the markets,” said Nithin Kamath, founder and CEO, Zerodha.

Volatility-centred

According to Zerodha, earlier there was no fixed VAR + ELM (value at risk + extreme loss margin) structure for Group 2 and 3 stocks. Now it is minimum 21.5 per cent VAR and 3.5 per cent exposure margin for group 2 and minimum 50 per cent VAR and 3.5 per cent exposure margin for Group 3.

For securities with intra-day price movements of over 10 per cent in the underlying market for 10 or more days in past six months, the minimum total margin would be equal to the maximum intra-day price movement of the security observed in the underlying market in the previous six months, the regulator said. It further said this will be continued till monthly expiry date of the derivative contracts that falls after completion of one year from the date of levy.

SEBI has reiterated that risk management is primarily the responsibility of clearing corporations (CCs) and the framework prescribed by the regulator is a minimum framework. It further said CCs are allowed to be more conservative according to their own perception of risk.

Published on February 25, 2020
This article is closed for comments.
Please Email the Editor