Guide To Understanding Margins in Options Trading

Published on Thursday, June 7, 2018 by Chittorgarh.com Team | Modified on Thursday, June 6, 2019

Beginners and many experienced traders find it tough to understand and calculate margins on Options. But margins are important as not maintaining the required margins can result in trade getting cancelled or fines levied by the exchanges. Understanding margins help you better manage your money as you don't have to keep too much or insufficient money in your account. You can use the excess money to trade.

Margins are an essential part of Options trading. It is the money or security a trader has to deposit in his account while trading in Options. Margin requirements are decided by BSE and NSE. The margins on Options vary depending on the type of Option and the underlying.

Margins on Options are different in nature from margins on stocks and futures. Margins on Options act as collateral whereas those in stocks act as leverage and increase the buying power of a trader.

What are different types of margins in Options Trading? How Options Margins are calculated?

Margins on Options comprises:

• Initial Margin or SPAN margin
• Exposure margin
• Assignment Margin

Let's understand the different types of margins in detail now-

What is Initial or SPAN Margin? How is it Calculated?

Initial margin is the minimum margin requirement for initiating an Options trade in the market. The margin is calculated based on a portfolio based approach wherein a collection of Option positions are grouped and different loss scenarios are considered. The margin is calculated using software called SPAN (Standard Portfolio Analysis of Risk).

The SPAN or initial margins are revised 6 times in a trading day. The initial margin varies for stocks and indexes and depends on the risk associated and historical volatility of the particular stock.

What is exposure margin and how is it calculated?

In addition to initial or SPAN margin, traders also need to deposit exposure margin. The exposure margins for stock options and index options are as follows:

For Index options: 3% of the notional value of open positions.

For Stock options: The higher of 5% or 1.5 standard deviations of the notional value of the gross open position in options on individual securities in a particular underlying.

The standard deviation of the underlying stock is computed on a rolling and monthly basis at the end of each month. The notional value is the value of the number of shares of the underlying in the contract based on the last trading price.

What is Assignment Margin?

The assignment margin is collected in addition to initial and exposure margin. This is collected on assignment from the sellers of the Options contracts. It is charged on the net exercise settlement value payable by the traders who are writing Options.

Margins for options buyers and sellers

Simply put, traders who are buying Options do not need to pay or deposit margins. They only need to pay the premium for the contract. This is because when you buy a Call or a Put Option, your potential loss is limited to the premium amount paid. You cannot lose more than the premium amount paid to buy the Options whereas your profit can be unlimited. As the risk is already covered by the premium amount, so there's no need to deposit a margin for Options buyers.

Options sellers have to deposit and maintain the margin as per the regulations of the exchange. It is because when you sell a Call or a Put Option, you receive a premium amount for the trade. This premium received is the maximum profit, you can make from the trade. However, the loss can be unlimited and depends on the closing price of the underlying.

Let's understand it with an example-

Suppose stocks of ABC company is currently trading at Rs 48. You expect the price to go downwards and so decide to sell a Call Option at strike price 50. The premium for the contract is Rs 3 and lot size is 100 shares. For selling the Call option, you will receive a premium of 100 * 3 = Rs 300

Now let's discuss the possible scenarios:

When stock price remains unchanged at Rs 48

The Options expires worthless and you keep the premium received. The premium of Rs 300 is your profit.

When the stock price goes down to Rs 28

The Options expires worthless and you keep the premium received. The premium of Rs 300 is your profit.

When the stock price, against expectations, goes up to Rs 68

The Call contract would be exercised by the buyer and you have to pay Rs 68-Rs 50=Rs 18*100= Rs 1800. Taking into account Rs 300 you received as premium, your loss would be Rs 1500.

When the stock price, against expectations, goes up to Rs 88

The Call contract would be exercised by the buyer and you have to pay Rs 88-Rs 50=Rs 38*100= Rs 3800. Taking into account Rs 300 you received as premium, your loss would be Rs 3500.

So, Option sellers have a potential for unlimited loss and to cover this loss, they are asked to deposit margins.

Margin Benefits for Multiple Positions

If you have positions in the Options contracts then you can get margin benefit i.e. lower margin requirement. However, the margin benefit is available for Options of the same underlying and is not available for Options of different underlying.

You also get margin benefits for the calendar spread positions i.e. positions in contracts with different expiry months. However, the margin benefit is removed 3 days ahead of the expiry date of the near month contract.