Page 190 - DCOM510_FINANCIAL_DERIVATIVES

Unit 12: Risk Management of Financial Derivatives

5. CMs are provided a trading terminal for the purpose of monitoring the open positions of Notes
all the TMs clearing and settling through him. A CM may set exposure limits for a TM
clearing and settling through him. NSCCL assists the CM to monitor the intra-day exposure
limits set up by a CM and whenever a TM exceeds the limits, it stops that particular TM
from further trading.
6. A member is alerted of his position to enable him to adjust his exposure or bring in
additional capital. Position violations result in withdrawal of trading facility for all TMs
of a CM in case of a violation by the CM.
7. A separate settlement guarantee fund for this segment has been created out of the capital
of members.
The most critical component of risk containment mechanism for F & O segment is the margining
system and on-line position monitoring. The actual position monitoring and margining is
carried out on-line through Parallel Risk Management System (PRISM).

Notes PRISM uses SPAN(r) (Standard Portfolio Analysis of Risk) system for the purpose of
computation of on-line margins, based on the parameters defined by SEBI.

12.2.1 NSCCL-SPAN

The objective of NSCCL-SPAN is to identify overall risk in a portfolio of all futures and options
contracts for each member. The system treats futures and options contracts uniformly, while at
the same time recognising the unique exposures associated with options portfolios, like extremely
deep out-of-the-money short positions and inter-month risk. Its over-riding objective is to
determine the largest loss that a portfolio might reasonably be expected to suffer from one day
to the next day based on 99% VaR methodology. SPAN considers uniqueness of option portfolios.
The following factors affect the value of an option:

1. Underlying market price
2. Strike price
3. Volatility (variability) of underlying instrument
4. Time to expiration

5. Interest rate
As these factors change, the value of options maintained within a portfolio also changes. Thus,
SPAN constructs scenarios of probable changes in underlying prices and volatilities in order to
identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin
requirement to cover this one-day loss.

12.2.2 Types of Margins

The margining system for F&O segment is explained below:
 Initial margin: Margin in the F&O segment is computed by NSCCL up to client level for
open positions of CMs/TMs. These are required to be paid up-front on gross basis at
individual client level for client positions and on net basis for proprietary positions. NSCCL
collects initial margin for all the open positions of a CM based on the margins computed by
NSE-SPAN. A CM is required to ensure collection of adequate initial margin from his TMs
up-front. The TM is required to collect adequate initial margins up-front from his clients.

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