New Risk Management Framework & Margin Structure for Hedged F&O Positions

New Risk Management Framework & Margin Structure for Hedged F&O Positions

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In addition to SEBI’s attempts to safeguard investor’s capital against risk & continued volatility due to global pandemic, new framework with regard to FnO margin requirements are going to implement with effect from 1 st June 2020. The regulatory board has tried its best to motivate the traders to make protective or hedged positions by extensively lowering the margin requirements for hedging while the naked positions will require raised margins. Wisdom Capital has always been to the fore in offering highest leverage across the brokerage industry and already operating on the same line of idea. For margins; please click fo-margin-requirements

The group of traders who shape their positions by mutually engaging various financial instruments like future & options are going to be aided in a big way. The probable returns for such low-risk technics will upsurge. For instance, the requirements for vertical spreads like Iron Condor to be discounted by howling 70%. The Price scan range which is used to determine F&O margins is now changed to 6 sigma from 3.5 sigma. This implies that when markets are volatile, the margin required for naked positions will be higher than before. With prolonged volatility,the margin required for naked positions is up by ~20%. The higher PSR means that there won’t be a sudden spike in increase or decrease of margin going forward, it will be gradual.

Major changes and their implications
Aspects Change Implication
EWMA Volatility Λ parameter changed 0.995 a. Volatility will have longer memory.
b. Margins will become more stable, will neither go
Volatility Margins based on 6σ/3.5σ a. Margins become conservative
b. Risk-based component of margin enhanced
Extreme Loss Margin Approximately halved Reduce the notional component of margin
Short Option Minimum Charge Discontinued Reduce the notional component of margin
Margins for obligations Net buy premium, settlement, replaced with COBG a. There was no margin earlier on end-of-day MTM gets introduced.
b. Single COBG means that offset between within same client permitted.
Achieving Stable and Conservative Margin: Simulation
CURRENT Vs NEW HEDGING MARGINS
Hedging combination Current Margin New Margin
a. Short Naked Future

b. Unhedged portfolio with unlimited loss
16.7%

~ Rs. 1,12,000 for 1 position (75 Nifty)
18.5%

~Rs. 1,24,000 for 1 position (75 Nifty)
a. Put call parity arbitrage (E.g. Nifty 9000 Call long, Nifty 9000 Put short, Nifty futures short)

b. Zero profit/loss, perfectly hedged position
Notional Margins: SOM: 5% on 1 short option ELM: 3% * √2 on future and short option

~ Rs. 90,500 for 1 position (75 Nifty)
Notional Margins: ELM: 2% on future and short option

~ Rs. 27,000 for 1 position (75 Nifty)
a. Call Spread (E.g. Nifty 11500 Call long Nifty 11600 Call short)

b. Only profit (realization) on liquidation
Notional Margins: SOM: 5% on 1 short option ELM: 3% * √2 on short option

~ Rs. 62,000 for 1 position (75 Nifty)
Notional Margins: ELM: 2% on 1 short option

~ Rs. 13,500 for 1 position (75 Nifty)