The Indian derivatives market is growing by leaps and bounds. The options market, in particular, has been witnessing a sharp rise in volumes consistently. That said, if you are planning to participate in options trading, you must first understand the concept of margins.
Margins play a vital role in options trading, especially when selling options. In this guide, we will delve into the importance of margins in options trading, why you should deposit a margin when selling options and how to calculate margin requirements using an options trading margin calculator.
Introduction to Margins in Options Trading
Before we explore the complexities involved with margin calculations, let us first understand what margins are in the context of options trading.
The term margin refers to the amount of money you must deposit with the exchange to cover potential losses from your positions due to adverse market movements. Imagine it as a kind of security deposit imposed by the exchanges to ensure you fulfil your obligations in case the market moves against you.
One of the most unique aspects of options trading is that the concept of margin applies only when you sell them. When purchasing options, you only need to deposit the full premium amount upfront. If the market moves against you, the maximum loss that you will incur is limited to the amount of premium you paid to purchase the options contract. However, this is not the case with option selling.
Why Should You Deposit a Margin for Selling Options?
Let us now quickly look at the logic behind margin collection when selling options before moving on to determining the margin requirements using an options trading margin calculator.
Selling options, also known as writing options, involves taking on a significant level of risk. Unlike buying options, where the maximum loss you can incur is limited to the premium paid, selling options can expose you to unlimited losses if the market moves sharply against your positions. Let us understand why this is so with the help of a hypothetical example.
Assume you have been closely following the movements of a particular stock for a long time. Based on your observations, you expect the stock price to fall in the future. You decide to capitalise on this potential price movement by selling the call option of that stock.
For this example, let us say that the stock’s current price is Rs. 2,000 and you sell one lot (500 shares) of call options with a strike price of Rs. 1,900. The premium of the call option contract is Rs. 100 per share, meaning that you would receive Rs. 50,000 (Rs. 100 x 500 shares) from the sale of one lot of call options.
Now, if the stock price falls as you expect on the contract expiration date, the call option you sold would become worthless and you would get to keep the Rs. 50,000 you collected as a premium. But what if the stock price rises instead? In this case, your losses would theoretically be unlimited since there is no limit to how much the price can rise.
This is precisely why exchanges require option sellers to deposit a margin. The margin you deposit when writing an option contract will act as a buffer to cover potential losses beyond the premium you receive. By depositing a margin, you essentially demonstrate your ability to fulfil your contractual obligations to the exchange.
That being said, what happens if the losses from your short position in an option contract exceed the premium you receive and the margin you initially deposited with the exchange? In such cases, the concerned exchange will issue a margin call, asking you to deposit additional funds over and above the initial margin to keep your positions open. If you do not fulfil the margin call within the stipulated time, the exchange will automatically square off your open position to prevent further losses.
Components of Options Selling Margin
Option writing margin has two components: Standard Portfolio Analysis of Risk (SPAN) margin and exposure margin. The SPAN margin system considers potential losses under different market scenarios and calculates the margin requirement based on the worst-case scenario. It is the minimum amount of margin you need to deposit to sell an option contract. It varies depending on factors such as the type of option, strike price, contract expiration date and the underlying asset's price and volatility.
The exposure margin, meanwhile, is an additional requirement over and above the SPAN margin. It is used to cover losses due to adverse price movements in the underlying asset due to increased volatility. The exposure margin is usually set at 2% and 3.5% of the contract value for index options and stock options, respectively.
How to Calculate Margin Requirements When Selling Options?
With so many factors influencing the margin requirements for selling options, calculating them manually can not only be challenging and complex but also prone to errors. Fortunately, there’s an easy way to determine margin requirements when selling options - using an options trading margin calculator.
An options trading margin calculator is a unique tool that lets you quickly calculate the margin you need to deposit to sell an option contract. One of the many advantages of using the tool is its simplicity. All you need to do is input a few values related to the trade you plan to execute. The calculator will display accurate results instantly, enabling you to plan your trades better. Here is a step-by-step overview of how to calculate margin requirements when selling options.
- Step 1: Select an options trading margin calculator of your choice.
- Step 2: Choose the trading segment you wish to trade in. Some of the segments for which you can calculate margin requirements include NSE and BSE futures and options, currency options and commodity options.
- Step 3: Select the underlying asset. Some calculators let you type the asset’s name in a search box to speed up the process.
- Step 4: Choose the contract’s expiration date. You can choose from three different expiries: near-month, next month and far-month.
- Step 5: Specify the quantity. Remember to enter multiples of the contract lot size and not a random number.
- Step 6: Enter the appropriate strike price of the option contract.
- Step 7: Choose the type of option you wish to sell: call option or put option.
- Step 8: Select the ‘sell’ option and then click on the ‘add’ button.
Once you click the ‘add’ button, the options trading margin calculator should give you an accurate estimate of the total margin requirement for selling the option contract, including a breakdown of both SPAN and exposure components.
As you can see, calculating margins for option writing is straightforward with an options trading margin calculator. The calculator helps you save time and effort and gives you accurate results based on the prevailing market conditions, which you can use to plan your strategies more effectively.
Make Your Options Trading Experience Seamless with the Samco SPAN Margin Calculator
Options trading is a fast-paced world that requires quick decision-making skills. One such tool that can streamline your options trading experience and help you make trading decisions swiftly is the Samco SPAN margin calculator.
It is a comprehensive tool designed to calculate margin requirements for options trading. Its simple and user-friendly interface is intuitive, allowing you to quickly calculate margin requirements for different option writing scenarios.
Since the options trading margin calculator uses real-time market data for its calculations, the results are highly accurate. You also get the flexibility to customise the parameters of the option contract and compare the margin requirements between the different variations.
With the Samco option calculator, you can optimise your options trading strategies and manage your margins more effectively. Access to such exciting tools and features is not the only advantage you get when you sign up for a trading and demat account with Samco. In fact, Samco’s brokerage charges are among the lowest in the industry, which can be hugely beneficial to you as an options trader, especially if you execute a large number of trades very often.
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