Subject: Derivatives and Risk Management Topic: Margining system in Future & Option and Securities Lending Mechanism

(SLM). What is Options Margin? Margin in equity and index options trading is the amount of cash deposit needed in an options trading broker account when writing options. Writing options means "Shorting" options and happens when Sell to Open orders are used on call or put options. Options margin is required as collateral to ensure the options writer's ability to fulfill the obligations under the options contracts sold. How is Options Margin determined? Options margin requirement is really the options trading broker's way of lowering the risk they face when allowing their account holders to write options. As the OCC ensures the fulfillment of all options contracts exercised, the responsibility falls on the broker should their account holder be unable to fulfill. This is why all options brokers would have their own way of determining how much options margin is needed for every scenario. The CBOE, Chicago Board of Exchange, also has a set of margin suggestions for all member firms which can be downloaded in pdf format at CBOE's Margin Manual site. However, you should understand the specific margin requirement of your options trading broker as it can be very different from what is suggested by CBOE. Some brokers have slightly more relaxed requirements while some other brokers have slightly stricter ones. No matter how much margin is required by each broker, margin requirements for stock and index options are always fixed percentage amounts to be applied uniformly in each scenario. This is unlike the variable margin requirement for futures options or options on futures. Calculation of Initial margins on futures: Futures margins are based on the volatility of the scrip. The formula applied is 3.5 times daily volatility in case of stock futures and 3 times daily volatility in case of index futures. Volatilities are updated on the nseindia website every day and can be reviewed by players. For example, if the daily volatility of Satyam is 4%, Satyam futures will attract 14% margins. Both buyers and sellers are charged equal margins in the futures market. This level is the Initial Margin. Calculation of Mark to Market Margins on Futures: Thereafter at the end of each trading day, Mark to Market Margins will be worked out. One party will make a profit and the other party will make an equal loss. For example, if you bought 1,200 units of Satyam Futures at Rs 226 each and the closing price comes to Rs 228,

you have made a mark to market profit of Rs 2. The party who has sold these Futures to you has made a loss of Rs 2. Thus, you will receive Rs 2 while the seller will pay Rs 2 through the exchange.

Securities Lending Mechanism (SLM): The stock lending borrowing mechanism helps an investor sell shares that he feels are overvalued, even if he does not own them. He does so by borrowing shares for a fee and returning them to the lender at the end of the tenure of the contract. The advantage for the lender is that he can earn a steady income on idle shares in his portfolio. The borrower (also the seller) is betting that the price of shares will decline, so that he can then buy them at a lower price from the secondary market and return them to the lender at contract expiry. In the latest set of norms that the regulator unveiled, the approved intermediary clearing corporation/clearing house will have the flexibility to decide the tenure up to a maximum period of 12 months. The lender/borrower will be provided with a facility for early recall /repayment of shares. In case the borrower fails to meet the margin obligations, the approved intermediary will obtain securities and square off the position of such defaulting borrower, failing which there will be a financial closeout, the new rules say. In case the lender recalls the securities anytime before the completion of the contract, the approved intermediary, on a best-effort basis, will try to borrow the securities for the balance period and pass them on to the lender. The intermediary will collect the lending fee from the lender who has sought early recall. In case of early recall by the lender, the original contract between the lender and the intermediary will exist till the contract with the new lender for the balance period is executed and the securities returned to the original lender. In case of early repayment of securities by the borrower, the margins will be released immediately on the securities being returned by the borrower to the intermediary. The intermediary will, on a best effort basis, try to onward lend the securities. And the income arising out of the same will be passed on to the borrower, making the early repayment of securities. In case the approved intermediary is unable to find a new borrower for the balance period, the original borrower will have to forego lending fee for the balance period. In case of early recall by the lender or early repayment of securities by the borrower, the lending fee for the balance period will be at a market determined rate.