SPAN (Standard Portfolio Analysis of Risk) and Exposure Margin are two types of margins required by exchanges to cover potential losses in derivatives trading. SPAN margin assesses overall portfolio risk, while exposure margin safeguards against additional market risks.
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What Is SPAN Margin?
SPAN Margin is the minimum amount of margin required by an exchange to cover the risk of a trader’s portfolio in derivatives trading. It calculates potential losses by analyzing various risk scenarios, ensuring sufficient funds to cover potential adverse market movements.
In more detail, SPAN Margin is calculated using a sophisticated algorithm that considers the worst-case scenario for a portfolio under different market conditions. It takes into account factors like price changes, volatility, and time decay. Exchanges use SPAN Margin to determine the amount a trader must maintain in their account to hold a position. This ensures that there is adequate capital to cover potential losses, thereby minimizing the risk of default.
SPAN Margin Example
An example of SPAN Margin can be seen in futures trading. If you hold a futures contract worth ₹5,00,000, the SPAN Margin might be calculated as ₹50,000, which you must maintain in your account to cover potential risks.
To explain further, consider you have a futures contract on a stock worth ₹5,00,000. The exchange calculates that the maximum potential loss under extreme market conditions could be ₹50,000. This ₹50,000 is the SPAN Margin, which you need to maintain in your trading account. If the market moves unfavorably, this margin ensures that there are sufficient funds to cover the losses without the need for immediate additional capital.
SPAN Margin Calculation
The SPAN Margin calculation involves assessing various risk factors like price movements, volatility, and time decay to determine the worst-case loss scenario. For instance, if a futures contract is valued at ₹5,00,000, and the calculated risk is 10%, the SPAN Margin would be ₹50,000.
In more detail, SPAN Margin is calculated by considering multiple factors such as the price of the underlying asset, historical volatility, and possible price changes in the worst-case scenario. For example, if you are trading a futures contract with an underlying value of ₹5,00,000, and the exchange determines a risk factor of 10%, your SPAN Margin would be ₹50,000 (₹5,00,000 × 10%). This margin must be maintained to cover any potential losses that may arise due to market fluctuations.
What Is Exposure Margin?
Exposure Margin is an additional margin required by exchanges to cover the potential risk of extreme market movements. It acts as a buffer over and above the SPAN Margin to protect against unexpected volatility or price swings in the market.
In more detail, Exposure Margin is calculated as a percentage of the value of the position and is required by the exchange to mitigate the risk of large, sudden price movements. While SPAN Margin covers the most likely risk scenarios, Exposure Margin provides extra security against extreme market conditions. For example, if you are trading futures worth ₹5,00,000, and the exchange imposes an exposure margin of 3%, you would need to maintain an additional ₹15,000 in your account.
Exposure Margin Example
An example of Exposure Margin can be seen in stock futures trading. If you hold a futures contract worth ₹5,00,000, and the exchange requires a 3% exposure margin, you must maintain an additional ₹15,000 in your account.
To explain further, suppose you have a futures contract on a stock worth ₹5,00,000. The exchange mandates a 3% exposure margin, which amounts to ₹15,000 (₹5,00,000 × 3%). This amount is in addition to the SPAN Margin and acts as a safeguard against significant market volatility, ensuring that your position remains adequately funded in the event of unexpected market movements.
Exposure Margin Calculation
The exposure margin calculation is based on a fixed percentage of the total value of the position, designed to cover the risk of unexpected market volatility. For example, if the exposure margin is 3% on a ₹5,00,000 futures contract, the required margin would be ₹15,000.
In more detail, exposure margin is calculated by applying a specific percentage to the total value of the position. This percentage is set by the exchange and varies depending on the type of asset and market conditions. For instance, if you are holding a futures contract valued at ₹5,00,000 and the exchange sets an exposure margin of 3%, you would calculate the margin as ₹5,00,000 × 3% = ₹15,000. This amount must be maintained in addition to the SPAN Margin to ensure sufficient coverage for the position.
What Is SPAN And Exposure Margin? – Quick Summary
- SPAN Margin and Exposure Margin are required by exchanges to manage the risk in derivatives trading.
- SPAN Margin covers potential losses by assessing risk scenarios in a portfolio.
- An example of SPAN Margin is the amount required for a futures contract, calculated based on possible market movements.
- SPAN Margin is calculated by considering factors like price changes, volatility, and risk percentage.
- Exposure Margin acts as an additional buffer against extreme market volatility, calculated as a percentage of the position’s value.
- An example of Exposure Margin is the extra amount required over SPAN Margin to secure a futures position.
- Exposure Margin is calculated by applying a fixed percentage to the total value of the position, ensuring added protection.
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SPAN And Exposure Margin Meaning – FAQs
SPAN Margin is the initial margin required to cover potential risks in derivatives trading, based on portfolio analysis. Exposure Margin is an additional margin imposed by exchanges to protect against unexpected market volatility and price swings.
The exposure margin for Nifty futures is generally set at around 3% of the contract’s value. This margin is imposed by the exchange to provide an additional safety net against significant market fluctuations.
The main difference between SPAN Margin and Total Margin is that SPAN Margin covers calculated portfolio risks, while Total Margin includes SPAN plus Exposure Margins, ensuring comprehensive protection against both regular and extreme market conditions.
To calculate SPAN Margin in NSE, use the SPAN calculator, which analyzes various risk factors like price changes, volatility, and market conditions to determine the minimum required margin for a derivatives position.
