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What is Mark to Market Margin in Futures and Options and when is it Applicable?

stock market
10 Feb 20206 mins readBy MOFSL

One of the basic concepts of risk management that underlies futures position is the initial margin that is collected from the clients who trade in the futures segment. The initial margin consists of the SPAN margin and the Exposure margin, the percentages of which are defined by the exchange on a daily basis. This is the amount that gets blocked upfront from your account. But then what if price movements are against you in the subsequent days? That means if you are long and the price falls or if you are short and the price rises, then what happens. For that you have another kind of margin called the Mark-to-Margin. The MTM margin is calculated on a daily basis and is debited or credited to your margin account. You may use margin calculator for your reference. So, what is mark to market margin in futures and what is the MTM meaning in trading? More importantly, how to calculate MTM for futures and options? But before you get into MTM, let us first understand the basic margin which is the initial margin.

Understanding the nuances of Initial Margin:

As stated earlier, the initial margin consists of the SPAN margin and the exposure margin. The SPAN margin is the basic margin that is calculated based on Value at Risk (VAR) method. The VAR takes into account the maximum loss that the stock can incur in a single day based on historical probabilities. The collection of SPAN margin is mandatory as per the SEBI and NSE rules and regulations. The exposure margin is an additional margin which is optional, but most brokers do collect the exposure margin too as an additional buffer of safety. Let us assume that for argument that you take a long position in PNB Futures and that the SPAN margin is 10.96% and the exposure margin is 6.23% taking the total initial margin to 17.19%. Look at the table below for PNB.

PositionLot SizePriceContract ValueSPAN MarginExposure MarginTotal Margin1 lot long on PNB Fut4000182Rs.728,000Rs.79,788Rs.45,354Rs.125,142

 In the above case, the broker will collect a total initial margin of Rs.125,142 if you initiate 1 lot long futures position in PNB. As stated above, this 17.19% of the value of the contract.

Understanding the nuances of Mark-to-Margins (MTM):

The concept of initial margin is central to understanding the concept of MTM margin. Each day the price moves up or down and therefore your margin money value gets adjusted to that extent. MTM margin helps us to understand if we still have the protection or we need to bring in more margins. At what point will the broker ask you to bring in additional margins or make a margin call? That is the question we need to understand from the table below. In the table we have simulated how the margin balance of the trader will get impacted when the price of PNB moves on a daily basis. Remember, that the trader is long on PNB. As a result, a rise in price will mean positive MTM and a fall in price will mean negative MTM. It is this impact that is captured in the Margin balance column at the end. In the case of PNB, we have clearly broken up the total initial margin into the SPAN margin and the exposure margin. Let us also understand why this break-up is important from the point of view of margin calls and additional margining requests by the broker.

PNB PriceValue of ContractSPAN MarginExposure MarginTotal MarginMargin
RequiredMargin BalanceRs.182Rs.728,000Rs.79,788Rs.45,354Rs.125,142Rs.125,142Rs.125,142Rs.179

Adjustment – Deduct (-Rs.3 x 4000)Rs.113,142Rs.171

Adjustment – Deduct (-Rs.8 x 4000)Rs.81,142Rs.174

Adjustment – Add (+Rs.3 x 4000)Rs.93,142Rs.169

Adjustment – Deduct (-Rs.5 x 4000)Rs.73,142

 
In the above table, the margin balance is adjusted on a daily basis based on the price movement of PNB. Since the trader is long on PNB futures, a fall in price is negative and any rise in price is positive for the trader. In practice, the initial margin requirement will also change on a daily basis, but we have just avoided that to keep this example as simple as possible. During the 4 trading days subsequent to the trade initiation date, the stock price is down on 3 days and it is up on 1 day. Thus on 3 days his margin balance has been depleted and only on 1 day has his margin balance seen an accretion. At what point will the broker make a margin call?

Making a margin call: At what point?

Margin call is when the balance of the margin account falls below a certain point. But what is that point? In the above case, the SPAN margin will be the point at which the margin call will be made. In the first 4 days, the margin balance had depleted but has not fallen below the SPAN margin level. It is only on the last day that the margin balance falls to Rs.73,142, which is below the SPAN margin requirement of Rs.79,788. At this point the broker will make the margin call and ask the client to replenish the account back to the initial margin level. If the client is not able to bring in additional, then the broker has the choice to terminate the position and debit the losses to the client account.
MTM measures your trading risk on a daily basis. It is a notional margin, but the actual margin call is normally made when the balance in the account goes below the SPAN level.
 

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