Hedged trades may cost less as Sebi likely to lower margin requirements

Hedged trades may cost less as Sebi likely to lower margin requirements

Initial margins that traders must pay exchanges include SPAN and Exposure.

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The cost of hedged trades will soon dip in the Indian stock derivatives market.

Traders using combinations of equity futures and options to create strategies that would result in limited losses could see margins for such bets decline significantly. The Securities and Exchange Board of India (Sebi) is expected to reduce the margin requirements for ‘hedged positions’ that could lead to the cost of such trades coming down by 60-70 per cent, two people familiar with the matter told ET. The plan to lower initial margins comes in the wake of a growing clamour among market participants to ease growing pressure of high trading costs.

Options segment contributed 92 per cent to the average daily turnover of Rs 16 lakh crore in the equity derivatives segment in January.

The issue of higher margins in equity derivatives was discussed in Sebi’s Risk Management Review Committee on Wednesday. The panel is said to have agreed in principle to the proposal to reduce margins on hedged positions, said one of the two people in the know. The regulator is expected to come out with the rules soon, he said.

Initial margins that traders must pay exchanges include SPAN and Exposure. Standard Portfolio Analysis of Risk (SPAN) is an upfront margin that traders pay up at the time of placing their trades. It is a percentage of the value of the trades based on the software SPAN. Exposure margin, a concept unique to few markets like India, is an additional margin levied that brokers also collect from their clients for trading in derivatives at the time of initiating a trade.

Currently, the total margin that traders pay upfront for a Nifty futures trade is around 10 per cent. Out of this, the SPAN mar gin is about 7 per cent, while exposure margin is 3 per cent.

As part of the margin rationa lisation exercise, Sebi is likely to reduce the contribution of ex posure margin and increase that of SPAN margin in the up front margin calculation, said one of the two people quoted above. The regulator could also ease the variables that form the SPAN margin, the person said which could result in a drop in margins for hedged trades.

Brokers said the reduction in margins on hedged positions will benefit derivative traders, especially those betting on indices and stocks through options.

“Traders who are active in limited loss options strategies like vertical spreads and iron condor are likely to benefit a lot,” said the head of a leading brokerage, which caters to a sizeable base of traders.

In many of such strategies, traders use a mix of options contracts or blend options and futures that end up being mutual hedges, thereby capping losses. Such trading bets are usually done by sophisticated traders with deep knowledge of the intricacies of the derivatives markets. The less experienced stick to plain vanilla strategies like buying or selling options or futures but many of such trades tend to be fraught with risks—in some cases unlimited. The benefit of lower margins will not be available for basic trades or ones where an investor buys futures or options as a hedge against his share portfolio.

Brokers said Sebi wants to encourage better-equipped traders to participate in the derivatives segment.

“If they reduce margins for hedged trades, it will be good for the derivatives segment. It will attract a new breed of traders,” said the CEO of a large retail brokerage, who did not want to come on record since Sebi is yet to finalize rules.

Brokers and traders have been crying hoarse, seeking a reduction in overall margins for derivative trades as the increase in trading costs had hit their profitability.

Sebi and exchanges have been tightening margin requirements for futures and options in the last couple of years.

Earlier this month, exchanges asked stock brokers to mandatorily collect the entire initial margin before a trade from clients even for transactions that are not carried forward to the next day.

This is expected to impact day traders, who took bets by bringing in just a fraction of the value of the transaction upfront.

Source- Economic Times.