The superiority of spreads and their absolutely dismal state

[nithin]

@Avi_Garg

What exactly does it mean when you say that the spreads themselves start trading on the exchange? As far as I know, you can execute spreads as a single order in the US as they have a complex order book. But that’s a thing just so traders are able to execute both the legs of their strategy simultaneously without much slippage. One can also create a spread by entering both the legs separately. But the end result is the same. How does it relate to the problem of exposure margin?

Even in the US option spreads don’t directly trade on the exchange. If the spreads did trade there won’t be any execution risk of not being able to exit one leg. Currently, calendar spreads of the future are the only thing that trades directly on the exchange.

@Avi_Garg

My idea is basically that you need to have sufficient margin in your account in order to close one of the legs in your spread. Otherwise, the order gets rejected.

@Avi_Garg

our concern regarding short strike being illiquid is valid but how does it relate to exposure margin? If a client is not able to exit his short option due to illiquidity, then that’s a liquidity problem. How is exposure margin doing anything to protect you from illiquidity?

Margins are collected to cover the risk. Higher the risk, higher the margin & vice versa. By collecting exposure margin the regulator’s expectation is that it is covering for the execution risk or one of the legs not being exited in a spread.

Currently, the exchange or broker systems don’t have the ability to block exits of positions because the margin post an exit isn’t sufficient. While this is on our list of things to do at Zerodha, unless an exchange/clearing corporation implements this, regulations can’t define a rule around it.

By the way, there have been enough discussions around this with the regulator. The margins for spread did drop when the new margin requirements were put in place. But I don’t know if it can go down lower from here given the current limitations in terms of not being able to have spreads trade as a single product on the exchange or inability to monitor margins post exit of a position & blocking exits if margin is insufficient.