Page 211 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes In India, however, unless banks and institutions enter the calendar spread in a big way, it is
possible that the cost of carry would be driven by an unorganised money market rate as in the
case of the badla market. These interest rates could be highly volatile.
Given the evidence that the cost of carry is not an efficient money market rate, prudence demands
that the margin on calendar spreads be far higher than international practice. Moreover, the
margin system should operate smoothly when a calendar spread is turned into a naked short or
long position on the index either by the expiry of one of the legs or by the closing out of the
position in one of the legs. The group therefore recommends that:
The margin on calendar spreads is levied at a flat rate of 0.5% per month of spread on the
far month contract of the spread subject to a minimum margin of 1% and a maximum
margin of 3% on the far side of the spread for spreads with legs up to 1 year apart. A spread
with the two legs three months apart would thus attract a margin of 1.5% on the far month
contract.

The margining of calendar spreads is reviewed at the end of six months of index futures
trading.
A calendar spread should be treated as a naked position in the far month contract as the
near month contract approaches expiry. This change should be affected in gradual steps
over the last few days of trading of the near month contract. Specifically, during the last
five days of trading of the near month contract, the following percentages of a calendar
spread shall be treated as a naked position in the far month contract: 100% on day of
expiry, 80% one day before expiry, 60% two days before expiry, 40% three days before
expiry, 20% four days before expiry. The balance of the spread shall continue to be treated
as a spread. This phasing in will apply both to margining and to the computation of
exposure limits.

If the closing out of one leg of a calendar spread causes the members’ liquid net worth to
fall below the minimum levels, his terminal shall be disabled and the clearing corporation
shall take steps to liquidate sufficient positions to restore the members’ liquid net worth
to the levels mandated.
The derivatives exchange should explore the possibility that the trading system could
incorporate the ability to place a single order to buy or sell spreads without placing two
separate orders for the two legs.

For the purposes of the exposure limit, a calendar spread shall be regarded as an open
position of one third of the mark to market value of the far month contract. As the near
month contract approaches expiry, the spread shall be treated as a naked position in the far
month contract.

13.3.11 Margin Collection and Enforcement (Clause 3.5)

Apart from the correct calculation of margin, the actual collection of margin is also of equal
importance. The group recommends that the clearing corporation should lay down operational
guidelines on collection of margin and standard guidelines for back office accounting at the
clearing member and trading member level to facilitate the detection of non-compliance at each
level.

13.3.12 Transparency and Disclosure (Clause 3.6)

The group recommends that the clearing corporation/clearing house shall be required to disclose
the details of incidences of failures in collection of margin and/or the settlement dues at least on
a quarterly basis.

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