What are the Different types of Margins

Last Updated: 14 Jan 2025

Types of Margins: Complete list of Different Types of Margins

In this segment, we look at the types of margins that are levied on cash and futures and options positions. There are various margin types ranging from initial margins to MTM margins, which you must be familiar with. These margin types also vary from one product to another. While understanding the different types of margins, it is important to first understand the concept of margins and the reason it is levied.

Remember that the different types of margins are a risk management measure and are based on a worst-case assessment. If the exchange does not have enough margins and the client defaults, then it creates a cyclical reaction in the entire system. To avoid such an eventuality, the different types of margins are levied on the trader. These different types of margins are applicable on the buy-side and sell-side of equity and derivative trades.

What are the Different types of Margins

Those of you who have been in the stock markets since 2000, would recollect the payment crisis at the Kolkata Stock Exchange in 2001 when the exchange came to the brink of default. Those were the days when margin rules were not so stringent and risk management was done a lot more on an ad-hoc basis. Today margining is a complete focused activity and monitoring of risks and exposures as well as client margins is at a real-time level. That is what makes the current margin system so effective.

In this segment we look at the different types of margins in the stock market; both in the cash segment and the F&O segment. The customer has to mandatorily deposit a certain amount of money with the broker to buy or sell stocks on the exchange. The margin is the name given to this amount of money, which almost serves as a caution deposit. The extent and amount of margin required to be paid by traders are determined by the exchange based on factors like volatility of the stock and other risk factors.

The logic of charging margins in equity trades

In equity trading, margins act as a safeguard against any losses brought on by unfavourable market movements for both the trader and the broker. Let’s look at an example to better grasp how margins operate.

Example Scenario: Let’s say a trader spends about Rs. 210,000 on 100 shares of Reliance Industries. The trader gains when the stock price rises, but what if it falls by 10% in a single day? The merchant would suffer a loss of Rs. 21,000 following such a drop. There is no problem if the trader has sufficient money to cover this margin. However, the margin that was initially placed must be used to cover the loss of Rs. 21,000 in the event that the trader defaults.

In the worst situations, where price swings could be substantial in a single trading day, margins are gathered to reduce the risk of such losses by covering possible market volatility.

Here is a quick look at the different types of margins in the cash market

There are a number of important margin kinds that traders must adhere to in the cash market:

Value at Risk (VaR) Margin

Based on a security’s past volatility, VaR is a statistical metric that calculates the highest possible loss it might sustain in a given day. Although the VaR margin helps to mitigate normal market risk, extraordinary market shocks (also known as Black Swan occurrences) may make it insufficient. The main method for figuring out margin requirements in equities trades is this margin.

Extreme Loss Margin (ELM)

The ELM accounts for possible losses that are not covered by the VaR margin. Previously optional, this margin is now mandated by the Securities and Exchange Board of India (SEBI) for brokers to collect from clients in addition to the VaR margin. In the event of unforeseen market shocks, the ELM offers an extra layer of protection.

Mark to Market (MTM) Margin

Applied in margin trading situations, the MTM margin is intended to take daily price swings into account. It guarantees that traders have sufficient margin to cover possible losses prior to the next trading session and that any price fluctuations that occur during the day are taken into account.

Peak Margin System

Under SEBI’s Peak Margin system, brokers must obtain margins up front in the form of cash or securities. Leverage is limited by the system to the sum of VaR and ELM. In addition, brokers must adhere to the peak margin system, which requires them to gather margins at four different times during the day. The client’s “peak margin” is the highest margin throughout these pictures. Completed on July 1, 2021, the system is designed to stop brokers from providing too much leverage.

Margin in derivatives segments

Because of the particular risks involved with these instruments, margining is a little different in derivatives markets like futures and options (F&O).

• Initial Margin (SPAN): The SPAN (Standard Portfolio Analysis of Risk) technique, which evaluates the portfolio’s overall risk, serves as the foundation for the initial margin in the F&O industry. SPAN margins fluctuate according to market volatility and are updated six times a day.
• Exposure Margin: In order to cover additional risks, the exposure margin is a necessary additional margin on top of the SPAN margin. The exposure margin, for example, is 3% of the notional value for index futures and options and 1.5 times the standard deviation of the stock price fluctuations over the previous six months for individual securities and stock options.
• Premium Margin: The highest possible loss on the position is reflected in the premium margin that option buyers must pay. In the event that the option position is exercised, this margin is intended to guarantee that the buyer can cover the loss.
• Extreme Loss Margin (ELM) in Derivatives: For index derivatives, the Extreme Loss Margin (ELM) is usually 2% of the notional value, while for stock derivatives, it is 3.5%. The purpose of this extra margin is to cover severe market swings that go beyond standard margin calculations.
• Mark to Market (MTM) Margin: In the event of an adverse price change in a futures or options transaction, mark to market (MTM) margins are applicable. The security is marked to the closing price to determine MTM losses, and the necessary margin is gathered prior to the start of the following trading day.
• Delivery Margin: In the final four days prior to expiration, delivery margins are applied to physically settled stock futures. After the settlement process is over, these margins are made available.

Interest and penalty on margins

A trader may be subject to penalty costs if they don’t supply securities for settlement or meet margin requirements. Default penalty rates are determined by the type and magnitude of the deficiency.

• For overnight payment shortages exceeding Rs. 5 lakh, a penalty of 0.07% of the default amount is applied each day.
• For deficits of less than Rs. 1 lakh or less than 10% of the required margin, trading or clearing members who report shortfalls are charged 0.5% of the order value.
• When there is a shortfall of Rs. 1 lakh or more, or when the margin shortfall is equal to or greater than 10%, 1% of the order value is levied.

Frequently Asked Questions

What is Margin Classification?

The term “margin classification” describes the grouping of several margin kinds, such as VaR, ELM, and MTM margins, which each address distinct trading risks. These categories make sure traders keep enough money on hand to handle any losses.

Is Margin Trading Risky?

Given that it increases both possible gains and losses, margin trading is indeed dangerous. Market swings can result in large losses that go much beyond the initial investment, so traders must adhere to various margin requirements, such as VaR and MTM, to reduce risk.

What is Margin in a Trading Account?

Margin is the collateral needed to open and hold positions in a trading account. Brokers gather a variety of margins, including MTM and VaR, to make sure there is enough money set aside for any losses.

Are there Specific Margins for Different Asset Classes like Stocks, Futures, and Options?

Yes, there are distinct margin requirements for every asset class. VaR margin is needed for stocks, SPAN margin is needed for futures, and premium margins are needed for options; these margins are all based on the asset’s risk profile.

What is the Minimum Amount for Margin Trading?

Each asset class and broker has a different minimum amount for margin trading; the necessary margins are usually stated as a percentage of the entire position value. Knowing the various kinds of margins is crucial to figuring out the precise need.