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SEBI gives margin reprieve to traders

Posted by Manish Agrawal on Wednesday, 10 September, 2008

Some good news for traders as well as brokers in the equity derivatives segment, who have been grappling with lacklustre volumes since the crash in the market in January this year.

Sebi has recently extended the calendar spread benefit while computing margins, till the expiry of the near-month contract. So far, this benefit was not applicable in the last three trading days, prior to expiry.

A calendar spread is a strategy where a trader takes a long and a short position in the same underlying (index or stock) but in two different contract series. For instance, he can short sell 100 contracts of Tata Steel July futures and go long with 100 contracts of Tata Steel August futures, or vice-versa.

Derivative traders use this strategy when they have a neutral outlook on the underlying asset (stock or index) in the near term, (i.e. till the current month contract expires), and have a bullish or bearish view on the same underlying over the far month.

Margins for calendar spread are lower since the risk — for the trader as well as to the system — is less because of the opposite positions. However, in the three trading days preceding expiry, the calendar spread benefit is not available, and the position is treated as a naked one.

As a result, traders end up paying margins on both legs of the trade. According to Sebi, “this leads to a sudden increase in margins without any corresponding increase in the risk of the spread position.”

“A quick look at the open interest build-up in both futures and options across stocks and indices will highlight the fact that calendar positions are built as we approach the expiry,” says Edelweiss Capital alternative derivatives desk manager Yogesh Radke.

There is a set of clients who are active in the calendar spreads product and use calendars to express their view on spread between futures basis and options-implied volatilities across expiries. Apart from this, higher working capital is needed during this period to provide margins to the exchange.

Now the recent Sebi circular says: “A calendar spread position on exchange-traded equity derivatives may be granted calendar spread treatment till the expiry of the near-month contract.” This means that the calendar spread benefit will now be available up to the expiry of the prevailing month’s contract.

So, brokers and clients will be benefited by this step in the expiry week where almost all market participants are relatively low on liquidity.

“For rollover positions, near and far-term expiry margins have been reduced from 20% to 4%. This means there are high savings in the working capital for institutional large value trades for broking houses and less capital blocked for individuals and retail investors,” says HDFC Securities managing director Aseem Dhru.

Translating this into numbers, it implies that a brokerage house needs to pay a margin of Rs 100 crore. Post this circular, the brokerage house would need to pay a margin of a mere Rs 20 crore, thereby resulting in huge savings of working capital towards the expiry period, on rollovers.

As per analysts, big brokerage houses like Edelweiss, Motilal Oswal, Religare and India Infoline will be better placed by this development.

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