Chapter 7 Currency Futures, Options and Swaps
Lead-in
Markets regulator Sebi(the Securities and Exchange Board of India)reviewed the margin framework for cash and derivatives segments on February 24, 2020, in order to bring more efficiency in the risk management system.The move has been taken to keep pace with the changing market dynamics and to bring more efficiency in the risk management framework.
The framework, which has been prepared in consultation with the capital markets regulator’s Risk Management Review Committee, will come into effect from May 1 this year, the Sebi said in a circular.Margin, in market parlance, is the minimum fund or security that an investor is required to pay to the stock broker before executing a trade.This is basically part of the money collected by bourses from brokerages as upfront, before giving exposure for trading in equity and commodity derivatives.With regard to margin framework for the cash market, Sebi has divided value at risk margin rates in three categories based on liquidity.
In respect of margin framework for derivatives, the regulator has reviewed its guidelines on volatility calculation, scan range on price as well as volatility, calendar spread charge on various products, minimum charge on short option, extreme loss margin and margin on consolidated crystallised obligation.Besides, there is a provision of additional margin for highly volatile stocks.“For securities with intra-day price movement of more than 10 percent in the underlying market for three or more days in past one month, the minimum total margins shall be equal to the maximum intra-day price movement of the security observed in the underlying market in last one month,” Sebi said.
This would be continued till monthly expiry date of derivative contracts that falls after completion of three months from date of levy, it added.For securities with intra-day price movement of over 10 percent in the underlying market for 10 or more days in past six months, the minimum total margins would be equal to the maximum intra-day price movement of the security observed in the underlying market in the previous six months, the regulator said.It further said this will be continued till monthly expiry date of derivative contracts that falls after completion of one year from date of levy.
Sebi has reiterated that the risk management is primarily a responsibility of clearing corporations (CCs)and the framework prescribed by the regulator is a minimum framework.It further said that CCs are allowed to be more conservative as per their own perception of risk.Earlier in January, the regulator has rationalised margin framework for the commodity derivatives segment, wherein clearing corporations need to categorise commodities as per their realised volatility.
Source: The Economic Times, Feb 24, 2020, https://economictimes.indiatimes.com/markets/ stocks/news/sebi-reviews-margin-framework-for-cash-derivatives-segments/articleshow/74287937.cms
In this chapter, we look at three types of derivative contracts: futures, options and swaps, with the aim of introducing the reader to their basic features.In particular, we emphasize how the contracts can be used for both speculative and hedging purposes and the advantages and disadvantages of them.