What Is Exposure Margin And How Well Do We Know It?

What is Exposure Margin?

Exposure margin is the second line of defence against market risks and volatility. However, to understand it better, one must be aware of the SPAN margin.

A SPAN margin stands for standardized portfolio analysis of risk. It is decided by a set of sophisticated algorithms. These algorithms check for risk and volatility measures against all portfolios and decide a margin, that will be used as cover.

Once that is done, a second margin is created depending on the degree of exposure each portfolio will be facing. That margin is called the Exposure margin.

Basics Knowledge for Beginner

The exposure margin, as stated is a protection that is created over and above the SPAN margin. At the time of initiating a futures trade, the initial margin needs to be adhered to by the investor.

The entire initial margin, which is nothing but the summation of the SPAN margin and exposure margin, is blocked by the respective exchanges.

This is primarily done to cover any future losses. As per SEBI guidelines issued on the 2^nd of July, 2018, it has become mandatory for the SPAN and the exposure margin to be blocked for an overnight position to be taken.

If the same is not followed a margin penalty will be levied.

It is imperative to remember that while the SPAN margin is calculated based on Risk arrays, the exposure margin is essentially decided by the broker.

This has led to a peculiar situation in the derivatives market.

Brokers and option writers would now have to collect the SPAN margin, exposure margin and any MTM losses at the beginning. Failing to do so will lead to a huge margin shortage penalty.

This decision was taken by the Risk Management Review Committee.

This was a momentous decision taken by the committee. The basis of this decision was that each portfolio would have to be secured against the change in price, market volatility and the sudden decrease in date to expiration.

Coming back to the basics, the cumulative charge levied for margin is called the total range = SPAN margin + exposure margin.

Difference between the SPAN margin and exposure margin

SPAN Margin	Exposure Margin
The SPAN margin is the margin which is calculated based on the risk assessment on portfolios against market risks, volatility et al	It is a cushion created over and above the SPAN margin. This is to provide additional protection to portfolios.
The SPAN margin is not a fixed margin. It keeps changing as per the changing risk factors.	It is a fixed entity since its only focus is to cushion portfolios against market upheavals.
The SPAN margin is based on the risk factor	It is based on the exposure factor.
The SPAN margin is calculated by a software	It is usually factored and calculated by the broker

With newer regulations kicking in, initial margins have now to be paid upfront, which was always the norm. However, those now include MTM losses too along with calendar spread margin. These have made the initial margin a costly affair.

However, if a margin shortage is found, a severe penalty is levied.

Risk and Benefits

It is also called the extreme loss margin. The reason for calling this as such is because of the degree of exposure each portfolio may be subjected to. This makes it an important cog in the wheel.

Risk scenarios have changed over the years. Market volatility, while not a new phenomenon, has evolved over a period in time. Newer risk factors have emerged while financial structures have transformed themselves.

The exchanges are no more mere financial functionaries but important edifices of economies.

To safeguard such institutions, the prime watchdog needs to constitute measures that will create a protective wall around the assets. If such a wall is not built, then there could be grave consequences.

However, a recent ANMI report suggested that margin costs were the highest in India. They called India the most margin heavy market in the whole world.

Compared to other markets and countries, a single margin is levied. This margin is usually the SPAN margin. The SPAN margin, as we have discussed previously, is a risk assessment done through risk arrays, to check the risk associated with the profit and loss of each portfolio.

This is the only protection that other economies take into account. However, India is the only country that levies a second margin, calling it the extreme loss margin.

ANMI rues the fact that SPAN is sophisticated enough to calculate the risk involved. And that it should constitute the majority of the margin cost.

The greatest heartburn occurs when the entire initial margin, which is the combination of SPAN and exposure margin, is blocked upfront. For most traders, this is a great shock and trading, therefore, becomes an unnecessarily costly affair.

Another aspect that defies logic is the way the margins are defined. We know that the SPAN margin is based on risks while the exposure margin is based on the degree of exposure. There have been instances when exposure has led to the reduction of risk.

In that case, the entire premise of high margins falls flat.

There is also a discrepancy that arises based on costs levied. India levies anywhere between 5 to 7.5 percent as a Short option margin. The relative levy in the global market is around 1 percent. This leads to a hedge position which becomes heavily margined.

The Inter commodity margin is also not passed on to the investor in India. In the global markets, this benefit is passed on to the trader.

Hence, margins become heavily skewed and balloons to more than 100 times the maximum risk. The resultant of this is that margins in India become more related to exposure than risk. In the global markets, this is usually the reverse.

The association is hopeful that such a draconian set of regulations would be eased or reworked. It would lead to greater efficiency of the system and there will be a definite reduction of costs.

The financial world works in a cycle. If there is a reduction in the upfront fees, more money can be invested into assets and portfolios and hence a greater volume of trade will be generated.

There are certain important pointers that one has to remember while trading concerning extreme loss margin.

In the equity derivative market, the net worth is calculated after deducting the SPAN margin and the exposure margin. This will be deducted from the liquid asset of the member who needs to be cleared.

The total margin is a non-negotiable entity and this amount has to be deposited in the account of the broker.

The margin call is an important notification sent out to the investor and under any circumstances, it has to be answered. If the broker finds that there are shortages in the margin, then he/she can sell or liquidate part of the securities or the entire set to maintain the minimum margin.

Every trading firm has a calculator that calculates the margin. These tools are called margin calculators.

The Zerodha SPAN margin calculator gives us a fair idea of the margin that needs to be paid upfront. It was also one of the earliest tools that provided its clients with a comprehensive set of information.

The NIFTY margin calculator is quite a handy tool. The Zerodha commodity margin list provides an exhaustive outlook on commodities and their intraday positions.

The 5 paisa span margin also provides us with the details of the intraday positions of portfolios. It does come with a margin calculator which becomes quite handy under these circumstances.

Margin calculators allow the traders to make informed decisions. The margin prices set by SEBI are among the highest in the world and hence one has to be exceedingly careful before gearing for trade.

How to Calculate Exposure Margin?

For index options and future agreements, the rate is usually 3%.

For example, if the contract value is INR 500000, then it would be 3% of the contract value ie: INR 15000

For options contracts and futures on individual securities

Under these circumstances, the rate is around 10% or 1.5 times the standard difference between the value of the opening position in futures of the contract. The higher value is always suggested.

Conclusion

The exposure margin is, as we have seen in detail, an ad hoc expense which is levied to create a second level of cushion. This is usually over and above the SPAN margin which is levied as the first level of protection.

It is calculated based on the exposure faced by each portfolio.

This cushion, unlike the SPAN margin, is a computer-generated based on a pretty powerful algorithm, which is calculated by the broker. Each brokerage firm has its own set of rates and it is prudent for a trader to research before a broker is selected.

The money saved on extreme loss margins can be invested in trading.

Exposure Margin FAQs

Q1: What is Exposure Margin?

It is the ad hoc margin added to a portfolio over and above the SPAN margin. It is based on the degree of exposure that a particular portfolio will face.

Q2: How is it different from SPAN margin?

As discussed previously, it is a cost levied by the broker rather than a computer-generated on. Also, it is not a variable margin and remains fixed throughout the trade. While the SPAN margin is based on the risk factor, the extreme loss margin, which is the other name for it, is calculated on the degree of exposure.

Q3: Do every broker charge it?

It is a mandatory requirement stated by SEBI. Every broker trading in the Indian stock exchanges is liable to levy it.

Q4: What happens if the margin is not maintained?

The initial margin is a combination of SPAN margin, Exposure margin, and market to market loss. This entire amount is blocked at the beginning of trading. If a margin shortage is found, then a strict penalty is charged on the trader’s account.

Q5: Is the collection of margin mandatory in the F&O segment?

The broker must collect the margin from its respective clients. This has to be done upfront. It is primarily done to cover for any loss that may arise due to market volatility.

Q6: What does the false reporting of the margin mean?

A margin can be collected through many modes. Cheque. Bank transfer or payment through card. This has to be reported by the broker to the exchange. Now if a situation so arises that a margin payment has not been made and the broker has the informed the same as a payment made, it will be construed as false reporting.

Q7: Are brokers allowed to share margin information with their clients?

It is an absolute necessity to send margin information to clients. And this has to be daily. The reason being that though the exposure margin is fixed, the SPAN margin keeps changing.

Also, for the records, every broker has to keep a detailed record of all the collaterals received from their clients. This safe bookkeeping is mandatory under the relevant laws.

It is also to be known to the brokers that the collateral deposited with them shall only be used for maintenance of margin and nothing else.

Proper audit trails shall also be maintained by the brokers.

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