The margin required is obviously 8%. So I have only 2,700,000 for 100 shorted call option. If the market moves 20% say on election result day, my obligation will be more than 50 lakhs. I am assuming the the broker does not get to square off the position. I don’t have that much money. What next? who pays?! This is like a real life scenario which could have happened on last LS election result day
In the client broker agreement, it is agreed that liability is on the client making the trade.
There are two parts to your question…
If you have shorted ATM Call on Nifty then you are basically short Delta. ATM options have a delta of 0.5. Hence assuming Nifty is 6500, Nifty goes up 20% (1300 points move) then your loss is minimum of (0.5*1300 = 650) points on the trade. Add to that the effect of time and volatility, your loss will be approximately 800 points.
Around the time of an event, the volatility shoots up…as a result a naked position such as the one above tends to lose a lot of money (if caught in the wrong direction). Hence the brokers as a part of their risk mitigation process increase the margins. I would assume around that time, your margin from typical 8% may increase to at least 20 or 25%…which means you deposit more money with the broker.
Also, as far as I know, the risk management system by NSE is quite comendable, I dont think there is a single case of default till now.
Typical clearing houses would start a default proceeding. However, in Indian market, we do beneficiary clearing and hence the onus is on the individual to deposit required funds. There are no lines of defense, apart from some company capital that the broker might have deposited at NSCCL. In essence, it is then economically prudent for the broker software to initiate auto-allocation of funds from the individual’s allocated pool to the margin requirement to a limit where the broker deems fit to keep the position open. The broker reserves the right to close out the position, should the position increase the liability on the broker/individual.
Which means, if you don’t have enough margin funds, be ready to be closed out and take in losses.
@Karthik : SPAN margins that are taken by NSE is anyway higher margins than necessary. Delta neutral strategies are still penalized for underlying’s movements. For example: if you sell 7500 call and 6500 put, which is a delta neutral strategy. The total span margins are 48k. 25k for call and 23 for put. Also, the impact of moneyness is very minimal. The difference in margins for 7500 call and 8100 call is only 3k. Considering this, NSCCL having to instrument a default would be next to 0. In fact, if they improve thier risk management system, there could be more liquidity in the market by freeing up any unwanted margin deposits.
@ravijini - No, the position will be squared off by the Risk Management team of the broker, it is usually done the moment the trader fails to maintain the required SPAN margin in his account.
The broker will give tolerance until all the Exposure Margin is eaten away as loss.
But once the loss enters the span margin requirement, your position will be squared off by the RMS team.
I am not sure whether the client will get a Margin Call, before squaring off?
Or the positions are squared off without clients knowledge and he will just get an sms, saying your positions are squared off. Its better if some senior could answer this!