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All you wanted to know about peak margin

Akhil Nallamuthu | Updated on October 11, 2021

On September 1, 2021, the final phase of SEBI’s peak margin rules kicked in, in the Indian stock market. These rules have been put into effect to contain excessive intra-day speculation which involves high risk, especially in the futures and options (F&O) segment.

These margin requirements were implemented in a phased manner from December 1 2020.

What is it?

To ensure that buyers in the stock market do have actual cash backing their trades, stock exchanges usually require something called a ‘margin’, or a minimum amount of cash or securities, to be held in one’s trading account to do a trade of a certain value. In India, SEBI recently brought in the concept of ‘peak margins’.

It has said that the margins that investors need to maintain with their broker for any trade will be calculated based on the maximum value of positions taken by them during the day. Earlier, margin requirements were calculated based on the closing positions of investors at the end of the trading day.

The margin provided can be in the form of funds or securities. In the cash segment, the minimum margin is at 20 per cent of the trade value and in the F&O segment it is the sum of SPAN and exposure margins, which can be different for each stock.

Suppose you buy a stock worth ₹1 lakh that requires 20 per cent as minimum margin, the upfront funds you need to maintain will be ₹20,000. The minimum margin however can go up depending on the stock. Stocks that are more volatile may require higher margins. For instance, the applicable margin rate for the stock of Indiabulls Real Estate on the NSE on Monday was 100 per cent — to buy shares worth ₹1 lakh, funds of ₹1 lakh should be maintained throughout the trading day.

Why is it important?

Margins allow investors and traders in the stock market to buy shares on credit. Lower the margin requirements, the less the own funds a person needs to invest to put through a trade. Peak margin rules intend to set tighter limits on the amount of leverage and thus risk an investor or a trader can take in their intra-day positions.

With margin rules that were based on end-of-day positions, traders and investors were able to ramp up their positions during the trading day with limited funds, while reducing them at the close of the day, to minimise margin requirements.

This in SEBI’s view, this resulted in excessive intra-day speculation adding risk for market participants and for the smooth functioning of the markets as well.

To make sure brokers collect the required margin from their clients, rather than checking margin obligations at the end of the day, peak margin rules now require brokers to check on their client’s positions four times during each trading day, at random. Of the four snapshots, the maximum exposure is used to calculate the client’s margin requirement.

Peak margin rules rein in the amount of leveraged trades at intra-day traders or derivative traders can put through on any given day. To this extent, they curb not only risk-taking but also liquidity.

Why should I care?

If you are a trader and used to take positions with intra-day leverage in excess of what is stipulated by the exchange, this will not be possible henceforth. Since brokers will be penalised if the margin collected is less than the peak margin obligation of their clients, they are expected not to offer such facility even though you may have a good relationship with them.

Seasoned traders may now need to put up more capital to effect the same value of trades as before, reducing their return on investment.

The bottomline

Leverage doesn’t just multiply gains, it magnifies losses.

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Published on October 11, 2021

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