# How Margin Calculator Helps Traders Manage Risks

Trading in the equity segment involves buying and selling of shares. Shares are exchanged for money. The buyer of shares gives away money to get shares while the seller of shares gives away shares to get money. However, things are a bit different in the derivatives market. In the derivatives market, there is no exchange of shares. It is purely speculation. It’s like taking a bet against each other without any involvement of actual shares. The one who is long on a particular contract expects the price to go up while the one who is short on the same contract expects the price to go down. Since there are no shares or collateral, counterparty risk arises where there is a chance that one party may not fulfil its obligation. Therefore, if anyone wants to trade in the derivatives (Futures & Options) segment, they are required to maintain a certain margin with their stock broker as prescribed by the exchanges. But what is this Margin, how is Margin calculated, and How much margin needs to be maintained? In this article, we will try to address all these questions. We will try to understand all about margins as well as how traders can take the help of a margin calculator to manage their risks.

## What is Margin?

Margin is an amount that a trader has to deposit with the stock broker before buying or selling derivatives like Futures & Options (F&O). The margin acts as a security deposit and helps to prevent counter-party risk in case of default. This is similar to the money that needs to be deposited with the landlord before we rent a property, so that in case the tenant defaults in payment, it can be deducted from the deposit amount. Margins are required to be paid by both the Long and short position holders. The margins are different from profit or losses. Margins are fixed by exchanges in order to safeguard stockbrokers when traders experience losses.

## What is a margin calculator?

Knowing how much margin is required to be maintained is essential before placing an F&O order. This is done with the help of a margin calculator. A margin calculator is an online tool that calculates the margin required for a particular trade, taking into account several factors such as time, price, and volatility. Higher the volatility, the higher the margins required. Also, the higher the probability of incurring a loss, higher is the margins. As per latest exchange circular, it is mandatory to collect SPAN margin, exposure margin and net buy premium margin at the time of placing a derivative trade by the stock broker.

## How is the Initial margin calculated?

Initial margin is the amount that is collected upfront at the time of entering a position in F&O trade. Initial margin is calculated on a portfolio of futures and option positions using a software called - SPAN (Standard Portfolio Analysis of Risk) and exposure margin. Initial margin = SPAN + Exposure margin While the SPAN margin is the minimum amount blocked when entering into an F&O position as per the calculation, exposure margins are money blocked over and above the SPAN margin to cover for any potential ATM (at-the-money) losses.

## What is SPAN margin?

SPAN margin is the minimum margin that is required to be collected by the stock broker when traders enter into a derivative contract. This margin is determined by exchanges. The span margin is variable, meaning it fluctuates throughout the day depending upon the volatility in the underlying contract. SPAN is a calculation developed by Chicago Mercantile Exchange (CME) and is used to calculate margins for derivative trades. SPAN uses scenario-based approach to arrive at the adequate margins. It generates about 16 different scenarios and for each of these scenarios, a possible loss that the portfolio would suffer is calculated. The maximum loss that the portfolio would suffer in any of the scenarios considered in one trading day would be the initial margin required to be paid. SPAN calculation logic is not disclosed publicly & it is a tough calculation. SPAN margin is monitored and is revised 6 times in a day. When the volatility in the position increases during the day, the stockbroker would call upon the trader to increase his margin. Similarly, when the volatility decreases the stock broker may release some of the margin blocked earlier. Investors can easily calculate SPAN margin at Samco app or website free of cost.

## What is exposure margin?

In addition to the SPAN margin, exposure margin is also collected by the stock broker to cover any additional risks that may arise due to erratic swings in the market or any Black Swan Event. This amount is decided by the stock broker. Unlike SPAN margin, exposure margin does not fluctuate and is fixed at the below rate:
• For index futures and index option sell positions, it is 3% of the notional value.
• For futures on individual stocks and sell positions in options on individual securities, it is higher of 5% or 1.5 standard deviation of the LN returns of the security over the last 6 months on the notional value of position.

## What is Premium margin and Assignment margin?

In addition to Initial Margin, a premium margin is also charged when buying an option contract. The premium margin is equal to the value of the options premium multiplied by the quantity of options purchased. Assignment Margin is collected on assignment from the sellers of the contracts.