Margins are required by the exchange and/or broker to maintain the position based on several factors. Traders shall ensure to have sufficient funds in their trading account to cover potential losses from the positions. Failure to maintain adequate margin may result in a margin call, which could require the trader to deposit additional funds or close out their position.
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Why Option Selling requires margins
When you sell an options contract, you receive a premium from the buyer of the option. However, you also need to provide a margin to the exchange in order to cover the potential losses that may arise from the position. So, the margin requirement for option selling is much higher than that for option buying, as the potential losses for option selling are unlimited.
The margin required for option selling is determined by the exchange and is based on various factors.
Volatility of the underlying asset
Strike price of the option
Time remaining until expiration
Size of the position.
The margin requirements can also change depending on market conditions, and exchanges may also impose additional margin requirements in certain situations, such as during periods of high volatility.
Two types of margins: SPAN margin & Exposure margin
What are Span Margins
This is a margin requirement set by the exchange using the Standardized Portfolio Analysis of Risk (SPAN) system. SPAN margins take into account the potential risk of the entire portfolio, rather than just the individual positions. It is calculated based on a variety of factors, including the delta of the option, the volatility of the underlying asset, and the time remaining until expiration.
The SPAN margin calculation is based on a complex algorithm that takes into account a variety of factors, including:
Price and volatility of the underlying asset: The SPAN system takes into account the volatility of the underlying asset and the potential for price movements in the future.
Correlation of prices: The SPAN system takes into account the correlation between prices of different contracts in the portfolio. This is important because it can affect the overall risk of the portfolio.
Time to expiration: The SPAN system takes into account the time remaining until expiration of the contracts in the portfolio. This is because options contracts can become more or less valuable as the expiration date approaches.
Strike price: The SPAN system takes into account the strike price of the options contracts in the portfolio. This is because options with different strike prices have different levels of risk.
The SPAN margin is calculated using a sophisticated algorithm that takes all of these factors into account. The algorithm analyzes different scenarios of potential price movements and calculates the maximum potential loss that the portfolio could suffer in each scenario. The margin requirement is set at a level that is designed to cover the potential losses under these scenarios.
What are Exposure Margins
This is a margin requirement that is specific to the individual position and is designed to cover the potential losses that may arise from the position. The exposure margin is calculated as a percentage of the notional value of the option contract and varies depending on the strike price and time remaining until expiration.
The margin requirements for option selling can vary depending on market conditions and may be subject to change at any time. It’s important for traders to regularly monitor their margin requirements and ensure that they have sufficient funds in their trading account to cover potential losses. It’s also important to note that brokers may require additional margin above and beyond the exchange requirements based on their own risk management policies.
Exposure margin is a type of margin requirement that is specific to the individual position and is designed to cover the potential losses that may arise from that position. The exposure margin for an option contract is calculated based on the notional value of the contract and is a percentage of that value. For example, if the notional value of an option contract is Rs. 100,000, and the exchange requires an exposure margin of 10%, the trader would be required to maintain Rs. 10,000 in margin to cover the potential losses from that position.
Options with a higher strike price and a longer time remaining until expiration are generally considered to be riskier, and therefore require a higher exposure margin.
Total margin
Total margin = SPAN margin + Exposure margin
Calculate margin requirements for your position here.
Caution to the traders
It’s important to note that exposure margin requirements may vary depending on the exchange and the specific contract being traded. Additionally, brokers may also require additional margin above and beyond the exchange requirements based on their own risk management policies.
Traders should always be aware of their exposure margin requirements and ensure that they have sufficient funds in their trading account to cover potential losses. Failure to maintain adequate margin may result in a margin call, which could require the trader to deposit additional funds or close out their position.
