When you purchase or sell futures and options (F&O) contracts at the stock exchanges, your stockbroker collects a fee known as margin. The purpose of collecting this margin is to provide you with a cover against the risk of adverse price movements. The two most common forms of margins are the span margin and the exposure margin.
Published on 20 February 2023
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The span and exposure margins collectively form the total margin. While the span margin is blocked as a mandatory requirement as per the rules of the exchanges, the exposure margin is blocked over and above the span margin to cover any potential at the money (ATM) losses.
In this article, we will discuss what is span and exposure margin and dive deep into the details of how each of these functions. Let’s get started.
What is Span Margin?
The span margin refers to the minimum required amount that is blocked by the stockbrokers for facilitating buying and selling of F&O contracts as per the exchange’s mandate. SPAN or Standard Portfolio Analysis of Risk derives its name from the software program used to measure portfolio risk.
The span margin is calculated using software to cover for the possibility of the worst price movement of the underlying stock. This is done by considering an array of risk factors that are responsible for the adverse movements of a stock.
The span margin for a security is never fixed. It can change from time to time depending upon the current market conditions. It can also change from one security to another based on the risks associated with that security. For instance, the span margin requirement for a single stock contract will always be higher than the index contracts since the former is riskier.
What is Exposure Margin?
The exposure margin is blocked over and above the span margin to ensure a cushion against any potential at-the-money (ATM) losses. The exposure margin is also known as the additional margin and is typically blocked at the discretion of the stockbroker.
The exposure margin is collected by the broker to protect itself against any liabilities that can arise due to sudden erratic swings in the market.
One way to understand the difference between the span and exposure margin is that the span margin is derived initially based on the risks and volatility associated with the underlying security. On the other hand, the exposure margin is the additional cushion that protects the broker against any unexpected losses due to sudden market movements.
Additionally, the exposure margin for a contract is fixed, unlike the span margin. As per the Securities and Exchange Board of India (SEBI) guidelines, the maximum exposure margin for F&O contracts can be 3% of the total value of the contract. For example, if a contract is valued at ₹1 lakh, the exposure margin would be 3% of ₹1 lakh, i.e., ₹3,000.
The Rule for Span and Exposure Margin
When you place an order for buying or selling an F&O contract at a stock exchange, you need to adhere to an initial margin. This margin is derived by combining the span and exposure margins. After getting a confirmation from you, the exchange will block the entire margin amount in your trading account.
As per the new guidelines that were implemented in 2018, both margins have to be blocked by the exchanges for overnight positions. Failing to adhere to this rule may attract a penalty.
Conclusion
To cover any potential losses due to adverse market movements, F&O writers need to maintain sufficient margin balance in their accounts. The span and exposure margins together form an initial margin that the exchanges block from investors’ accounts.
While the span margin for security can change from time to time depending upon the risks and prevailing market conditions, the exposure margin remains more or less fixed. The stockbrokers also have the option to reduce exposure margins to attract more clients.
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While investing in the stock markets, there are several things that you need to look at. One such factor is the volume of a specific stock being traded at a given point in time. In the stock market, many trade exchanges take place every day. While some investors buy and sell their stocks on the same day, others hold them for a longer period.
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