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What is Span and Exposure Margin

28 Aug 2023

Introduction:

Every time you trade in Futures and Options (F&O) contracts on the stock markets, your stockbroker levies an amount known as the ‘Initial Margin’. The objective of collecting this margin is to mitigate the potential loss you may incur in the case of adverse market movements.

You can calculate your total initial margin by combining the two types of margins – the Span Margin and the Exposure Margin.

Thus, the formula for calculating the initial margin for an F&O trade is as follows:

Initial Margin or Total Margin = Span Margin + Exposure Margin

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But now, you must be wondering what is a span margin and an exposure margin. The span margin is the minimum requisite amount you must pay for F&O transactions as per the rules of the stock exchanges. On the other hand, the exposure margin is an additional margin collected by the stockbroker to mitigate unforeseen At The Money (ATM) losses.

This article discusses span and exposure margins in detail and also explores their differences. Continue reading for a better understanding.

What is a span margin?

As mentioned, the span margin is the minimum amount you must pay your stockbroker before writing a Futures and Options position. An indemnity is collected to cover a trade against any unexpected loss arising from adverse price movements. The span margin is also known as the VaR margin in the stock market.

The stock exchanges have a standardized formula for calculating the span margin. A software called the Standard Portfolio Analysis of Risk (SPAN) calculates margin requirements for F&O trades in India in commodities, equities, and currencies. The term ‘Span Margin’ has been derived from the name of this software only.

How is the span margin calculated?

A fixed system calculates the span margin to account for the worst possible movement in the price of an underlying security. It's done by assessing various security factors that define potential loss or gain for an F&O contract under the given circumstances. These risk factors include price changes due to market volatility, theta decay, etc.

The span margin may vary from asset to asset, depending on the overall risk associated with a particular security. For example, the span margins for trading F&O contracts with shares as underlying assets are usually higher than those for trading F&O contracts with indexes as underlying assets. Furthermore, the lower the volatility in a security, the lesser the span margin requirement, and vice-versa.

To get an estimated idea of the span margin before entering a position, you can use an online margin calculator of your stockbroker. You will also find several third-party margin calculators on the Internet.

What is an exposure margin?

The exposure margin is collected over and above the span margin to cover adverse price movements during an F&O trade. It is usually at the discretion of the stockbroker. The exposure margin is also known as the additional margin.

A stockbroker collects the exposure margin before a trade to protect itself against the potential financial liability of irregular market swings.

So, you can say that the span margin is calculated based on the initial risk factors associated with the underlying securities and is mandatory as per the exchanges. It already covers the market volatility risks. On the other hand, the exposure margin is the additional margin collected by the stockbroker and acts as an extra safety cushion to safeguard them from unforeseen losses.

Unlike the span margin, the exposure margin is fixed for all securities. As per the Securities and Exchange Board of India (SEBI) guidelines, the exposure margin cannot exceed 3% of the contract value. For example, if you’re trading a Nifty F&O contract valued at Rs. 10 lakhs, the maximum exposure margin you’ll have to pay is 3% of Rs. 10 lakhs, i.e., Rs. 30,000. To get an idea of the exact exposure margin, you can use your stockbroker’s exposure margin calculator.

To conclude

Hopefully, after reading this article, you better understand span and exposure margins. These margins are meant to mitigate the losses arising from adverse market movements. However, the collection of span margin is mandatory as per the stock exchange rules, while that of exposure margin is at the discretion of the stockbroker.

As an investor, you must maintain a sufficient balance in your trading accounts to cover these margins. With Motilal Oswal, you can open a free Demat-cum-trading account and start investing in shares and derivatives seamlessly.

 

Related Articles: Difference Between Margin Trading and Leverage | What is Evening Star Candlestick Pattern | Difference Between Margin Trading And Short Selling | What is trading on equity

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