In the last seven months, the NSE and NSE Clearing Ltd, in consultation with the Securities and Exchange Board of India (Sebi) and other exchanges, have issued at least seven circulars on the subject of Additional Surveillance Margin (ASM) applicable on equity derivative trades. These are part of the costs you pay in order to trade in derivatives.
According to the latest circular, dated 12 September, a newly defined margin is to be applied across all in futures and options (short) contracts open in the market, effective 14 September, and will increase in a phased manner till 30 November.
While it appears complicated for retail investors, data suggests retail investor participation in the derivatives market is increasing over the years. According to daily trade data from NSE, the daily turnover in the cash or capital market (when you simply buy and hold the stock or an exchange-traded fund) is only 1.5% of the turnover in the futures and options (derivative) segment. In financial year 2017-18, retail trades or trades by individual investors accounted for 45% of the gross turnover in the futures and options market.
If you write or sell options or trade in index or stock futures, here’s what the new circular on ASM means for you and what impact it can have on the nature of trades.
What it means for you
If you are a regular futures trader or options writer, your cost of transaction is going to increase. You are already paying the initial or SPAN or Standard Portfolio Analysis of Risk margin plus exposure margin. After ASM got introduced earlier this year, margin requirements have increased.
Till recently, ASM was calculated on the basis of market rise and fall scenarios, provided potential loss exceeded ₹ 1 crore. This meant that large-sized portfolios were most impacted.
The latest circular by NSE Clearing states that the current initial plus exposure margin in index options covers risk for around 6% change (price movement, up or down) in underlying indices; in index futures, they cover risk for around 8% change. Similarly, current margins for single stock derivatives cover risk for around 12.50% change in underlying stocks. ASM has been added in such a manner that the calculation of initial margins shall be amended, in steps, to increase the coverage of risk to the extent of 10% change in underlying indices and 17.50% change in underlying stocks.
In other words, the margin paid on all derivative trades is set to increase, and not just for large-sized trades where the loss is above ₹ 1 crore. But since one trader can have many derivative trades, some of which may be for hedging risk, the margin increase will take into account portfolio level risk in adding incremental margins.
“With respect to equity derivatives , the initial circulars around increased margins came out in early 2018, perhaps in anticipation of event-based risk in the market. The objective may be to reduce overall leverage in the market which could exaggerate the fall in case of a correction. However, the way SPAN margin works, it already covers 99% of the risk scenarios. In addition to SPAN there is an exposure margin levied basis open positions. While the earlier calculation of ASM impacted large sized portfolios the most, the latest circular means that all portfolios will have increased margin payment," said Ashish Rathi, whole-time director, HDFC Securities Ltd.
Why was ASM introduced?
In February 2018, Sebi along with the exchanges introduced Graded Surveillance Measure on certain defined securities. The circular stated that the purpose of such measures was to caution investors while dealing in certain securities and advise them to carry out relevant research before doing so. What the measures effectively do is increase the cost of taking the risk of trading in such securities.
The ASM measures which were subsequently introduced aim at warning investors about the risk involved in their derivative portfolio. At the same time, the enhanced margin was meant to protect against a systemic issue in times of sharp correction. “If the regulator intends to reduce systemic risk and decrease retail investor participation, one way to do it is by increasing margins," said Abid Hassan, founder Sensibull, an online options trading platform.
The earlier version of ASM affected large-sized clients the most, blocking most of their trading account money, making it hard to indulge in other trades and forcing them to sell some of their positions. Some experts believe the scenario of 20% single-day loss superimposed on SPAN scenarios was perhaps too harsh. The redefined measures are more pervasive but will also dent volumes.
“What would be nice is if exposure margin was let go of and was incorporated within SPAN margin. This would incentivize traders, arbitrageurs and hedgers, which will be good for the industry," said Nithin Kamath, CEO and founder, Zerodha.
In the options segment, by increasing the margin in options selling or writing (option buying does not have a margin), traders may inadvertently shift more to option buying; this may be more harmful than intended.
“Small traders usually buy options and large traders sell. But selling options is more profitable in the long run and retail investors will keep losing money till they are only focused on buying. This happens because there is a tendency from option buyers to put a bulk of their funds as premium in high pay-off but unlikely option scenarios. Out of money options, which have a low probability, usually expire without making money; the investor loses all the premium paid. Knowledge is a problem. Option traders need to understand the value in having a combined strategy with both buying and selling," said Hassan.
Will it reduce systemic risk? If some of the existing traders exit, thanks to higher cost, the volumes will go down, and higher margins in times of high risk also mean that immediate selling pressure is low. It will, however, not protect a retail investor just starting out in the derivatives market from losing money. For that, a lot more awareness needs to be created about the nature of these products. If you are not an experienced derivative trader, it’s best not to take on this risk and stay away.