Derivatives or Future & Options (F&O) segment accounts major volume of trades in the stock market where people buy and sell underlying stocks, and indices in lots through contracts that expired at a specified period and squared off or end on that date.
However, trading in the F&O segment you don’t need to invest all the money as per the value of your trade, instead, you have to deposit a certain portion as margin money and when the stock price changes the margin money is adjusted or trade settled when a contract is expired on the date of expiry of the contract.
Also Read: Options Trading: How it Works, Example & How to Trade
And maintaining the margin is one of the challenging tasks for traders to avoid the margin penalty that is imposed by the exchange. As per the SEBI Rules, a margin shortfall penalty is levied on any positions that do not have appropriate margins.
Thus, if you are dealing with intraday or trading in the F&O segment, you must understand the F&O Margin Penalty and everything else to maintain the margins and how to avoid the penalty. Here, we will discuss the F&O margins, penalty charges, what are the rules & regulations formed by SEBI and how to avoid F&O Margin Penalty charges.
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What is F&O Margin?
If you want to trade in F&O, your broker will ask you to deposit a certain amount as a margin of money in your trading account. In this segment without funding your account with margin money, you cannot initiate the trade, either you are buying or selling.
The Future & Options margins are collected by the brokers, on behalf of stock exchanges to cover any potential risk of any unexpected rise or fall in the stock or underlying index’s price. And the margin keeps changes the end of the day as per the price changes.
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Why F&O Margins are Collected?
When you buy an options contract the risk is limited to the premium you paid at the time of buying the contract. While, when you sell the future or options contract, the risk is unlimited and here to cover this risk, the broker collects the margins from you. Collecting the margin money from the traders in F&O helps to reduce the risk of any default by traders.
Types of F&O Margins Attract Penalty
Three types of F&O margins are charged by the broker as per the different market conditions and types of trade that take place.
SPAN Margin: Standardised Portfolio Analysis of Risk (SPAN) is the margin based on the concept of value at risk. This margin is calculated in such a way, that it can cover the maximum potential loss that can happen in same-day trading. And as per the underlying stocks’ high volatility or volatility of index (VIX) for indices, the F&O contracts on the stock or index will have a higher SPAN margin.
Also Read: VIX India: How it Works, Calculated & Used for Share Trading
Exposure Margin: The exposure margins are imposed extra and beyond the SPAN margin. These exposure margins are created to cover the risks that are not covered under the SPAN margins. As per the SEBI, for the Indian stock market, trading in the F&O segment, the exposure margin for stock F&O contracts is fixed at 5% and for index F&O it is set at 3%.
MTM Margin: MTM or mark-to-market margin is deposited with brokers to cover the daily volatility that happens in the price of the F&O contracts. This margin is required as your underlying security price keeps changing. Suppose the security contacts price you bought, is falling or the security contract you sold is rising against your expectations, then a broker will collect MTM each day to cover the loss that arises due to an unexpected price change.
How to Calculate F&O Margin?
As per the buying and selling of the underlying assets, the F&O margins are calculated. You can find the F&O margin calculator as per the below situations.
In Case of Buying Options Contracts:
The option premium + other delivery margins may be charged before the physical settlement.
In the case of Selling Options Contracts and Futures Contracts:
SPAN + exposure margin + other delivery margins that may be charged before the physical settlement + any other margins levied by the exchange
Apart from these two, depending on the trader’s background or trading history in the F&O segment, to cover any additional risk, the broker might also charge an additional margin that may be far beyond the margins levied by the stock exchange.
What is F&O Margin Penalty?
The F&O margin penalty is you can say a type of fee or charge you have to pay to your broker that is further paid to the stock exchange for not maintaining the required margins when it is short. And this penalty is calculated, in percentage on the margin amount shortfall and charged on daily basis till the required margin is settled.
SEBI F&O Margin Rules
According to the SEBI, the penalty is applied when sufficient margins are not maintained and as per the rules, it is mandatory required that the latest SPAN & Exposure or stock physical delivery margins be available in the client’s derivatives allocation.
However, the shortfall of margin can be happened due to various reasons like an increase in the margins requirement by the exchange, removal of hedge position, and mark-to-market losses. Under these conditions, the penalty is imposed as a proportion of the shortfall amount that is defined by the regulations that are deducted by the broker and deposited to exchanges.