Moving the Covered Way

Risk-takers are paying a steeper price to participate in India’s equity derivatives market. Traders betting on the direction of the index or a stock without insurance are paying higher upfront money. The changed rules, however, encourage safer strategies like hedged trades, where margins are lower.

What has changed? NSE has tweaked a parameter used to calculate Standard Portfolio Analysis of Risk (SPAN) — an upfront margin paid to the broker before placing trades. The margin is a percentage of the trade value based on the software SPAN. The exchange has raised the Price Scan Range (PSR), which is a variable to determine SPAN margins. By increasing the PSR, the upfront margins, too, have spiked.

Plain vanilla strategies like Long or Short Futures or Short Options are riskier than simply Long Options. So, the margin requirement on such trades have been increased. For instance, the initial margins for buying Nifty futures from has increased by nearly 25%.

This comes at a time when the regulator is pushing brokers to mandatorily collect the entire initial margins before trade initiates, may it be an intraday trade. Regulator and exchange are constantly working towards creating an efficient margin system in terms of calculation and collection. All this will impact the derivatives market in terms of liquidity and participation.

The new upfront margins would, however, benefit traders using combinations of equity futures and options to create strategies that would limit losses. Such trading bets are usually done by sophisticated traders with deep knowledge of the intricacies of the derivatives markets. 

These traders will soon catch the flavour of the market as the margin requirement is lower by nearly 50%, improving the RoI significantly. So, not only one has lower risk but also better returns. The is clearly a win – win situation.

For instance, if one goes Long on July Reliance Futures right now, the margin would be Inr 2,50,000. For the same position along with at Long 1700 July Put will bring down the margin requirement to Inr 95,000. 

Similarly, if one shorts at Nifty 11000 July Call the margin needed would be nearly Inr 1,10,000. This along with a Long 11300 July Call, would reduce the margin requirement to nearly Inr 34,000. The additional cost of hedging would be near Inr 2400/-, while the margin saved Inr 76000. Considering 12% p.a. opportunity cost, it will bring down the hedging cost to near Inr 1600/-. Not missing the protection that it provides.

Clearly, as compared to naked writing, a hedged position is surely a better strategy from risk management perspective. Now, with the new margin rules, makes it further lucrative from an RoI standpoint also.

Happy Trading!!!

Cheers.