Page 195 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes Short Option Minimum Margin: Short options positions in extremely deep-out-of-the-money
strikes may appear to have little or no risk across the entire scanning range. However, in the
event that underlying market conditions change sufficiently, these options may move into-the-
money, thereby generating large losses for the short positions in these options. To cover the
risks associated with deep out-of-the-money short options positions, SPAN assesses a minimum
margin for each short option position in the portfolio called the short option minimum charge,
which is set by the NSCCL. The short option minimum charge serves as a minimum charge
towards margin requirements for each short position in an option contract.

Example: Suppose that the short option minimum charge is ` 50 per short position. A
portfolio containing 20 short options will have a margin requirement of at least ` 1,000; even if
the scanning risk charge plus the calendar spread charge on the position is only ` 500.
The short option minimum margin equal to 3% of the notional value of all short index options
is charged if sum of the worst scenario loss and the calendar spread margin is lower than the
short option minimum margin. For stock options it is equal to 7.5% of the notional value based
on the previous day’s closing value of the underlying stock. Notional value of option positions
is calculated on the short option positions by applying the last closing price of the relevant
underlying.
Net Option Value: The net option value is calculated as the current market value of the option
times the number of option units (positive for long options and negative for short options) in
the portfolio. Net option value is added to the liquid net worth of the clearing member. This
means that the current market value of short options is deducted from the liquid net worth and
the market value of long options is added thereto. Thus mark to market gains and losses on
option positions get adjusted against the available liquid net worth.

Net Buy Premium: To cover the one day risk on long option positions (for which premium shall
be payable on T+1 day), net buy premium to the extent of the net long options position value is
deducted from the Liquid Net worth of the member on a real time basis. This would be applicable
only for trades done on a given day. The net buy premium margin shall be released towards the
Liquid Net worth of the member on T+1 day after the completion of pay-in towards premium
settlement.

Task Evaluate the Bank’s participation in derivatives markets in India.
12.3.3 Overall Portfolio Margin Requirement

The total margin requirements for a member for a portfolio of futures and options contract
would be computed by SPAN as follows:
1. Adds up the scanning risk charges and the calendar spread charges.

2. Compares this figure to the short option minimum charge and selects the larger of the
two. This is the SPAN risk requirement.
3. Total SPAN margin requirement is equal to SPAN risk requirement less the net option
value, which is mark to market value of difference in long option positions and short
option positions.

4. Initial margin requirement = Total SPAN margin requirement + Net Buy Premium.

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