Margin Money - What is margin money?

Margin money has different implications in the capital markets. One way to look at margin money is when you take funding for buying shares in the IPO market or in the secondary market. The financer will only fund part of the capital and you need to put in the balance as margin. Secondly, we have the margin that is payable when you initiate a futures trade or an option sale. In this case, the exchanges use the VAR (Value at Risk) approach to determine how much of margin you need to pay. Lastly, when traders initiate intraday trading positions, they need to pay cash margins as a safety net against volatility. Margin money in the stock markets can mean any of these. However, the principle behind collecting margin money remains the same; and that is to mitigate the risk. The trading terminal as well as the broker website provides the margin calculator which can be used to calculate margin against shares. Let us now look at why are margins collected?

Here is why margins are collected

1. Margins instill a sense of involvement in the trader since they have committed funds to that trade. It has been observed that traders behave more rationally when they have their skin in the teeth.

2. Margins are a part of normal risk management practice. The exchange clearing corporation guarantees every trade on the stock exchange and they need some kind of safety net to fall back upon. That is provided by margins.

3. Margins are based on the concept of VAR that means it will cover the maximum loss in a single day in 99.7% of the occasions. This reduces the risk of any exchange default, which normally has a chain reaction.

4. When margins are collected from the client, the broker is not put at undue risk because it is ultimately the broker who, as a member, is answerable to the exchange. Margins help to mitigate the broker risk.

Types of margins collected – Upfront margins

There are upfront margins that are collected at the time of initiating the trade and then are daily margins that are imposed based on price movement. Let us look at upfront margins first.

Initial Margin

Initial margin is the cash deposit required when opening a new futures long / short or options short position. Initial margin is determined as a percentage of the full contract value. Initial margin varies according to the futures market that you are trading. In single stock futures, the required initial margin can vary from 15% to 70% depending on the risk of the stock. For example, the percentage margin payable on Hindustan Unilever will be low but it will be high on Yes Bank. This is also called the SPAN margin.

Exposure Margin

In India, the exposure margin is also called the extreme loss margin (ELM). In the past, ELM was not mandatory and brokers only had to collect the SPAN margins. But now, SEBI has made collection of ELM also mandatory for all trades. ELM is levied on top of the SPAN margin and varies between 5% and 8% depending on the risk of the stock. Brokers who do not collect the exposure margins are penalised by the exchange. The SPAN margin and the ELM combined become the upfront margin payable.

Types of margins – Daily margins

The most common type of margin charged on a daily basis is the MTM (mark to market) margin. This is applicable on long and short futures position depending on the price movement. MTM is only applicable if the price movement goes against your position. Normally, MTM is debited or credited to your margin account and the margin call is made by the broker only if your balance goes below the maintenance margin.

In addition, there are margins like volatility margins and additional special margins (ASM) that are imposed by SEBI from time to time. The purpose of margins is basically that of managing risk.