FAO Risk Management Concept

NSE.IT

RISK MANAGEMENT CONCEPTS(NEATXS VERSION 3.5 ONWARDS)

NSE.ITTRADE GLOBE

GROUND FLOOR ANDHERI-KURLA ROAD

ANDHERI (E) MUMBAI 400 059

22-july-2003

All rights reserved. No part of this document may be reproduced or transmitted in any form and by any means without the prior permission of NSE.IT

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TABLE OF CONTENTS

1 INTRODUCTION TO FAO RISK MANAGEMENT............................................1

2 INTRADAY TURNOVER LIMITS.........................................................................1

3 SHORT OPTION LIMITS........................................................................................1

4 MARK TO MARKET (MTM) LIMITS..................................................................2

5 MARGIN LIMITS.....................................................................................................2

5.1 VALIDATIONS FOR MARGIN LIMITS......................................................................25.2 COMPONENTS OF MARGIN LIMITS.........................................................................2

5.2.1 Portfolio based Margin..................................................................................35.2.2 Net buy Premium...........................................................................................55.2.3 Realised loss..................................................................................................65.2.4 Exposure limit................................................................................................7

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1 Introduction to FAO Risk Management

For the purpose of risk management, deposits are defined for the user and multipliers assigned to the deposits in order to arrive at the limits. The following limits are defined for risk management:

Intraday Turnover LimitsSO Limits (only for clients)MtM LimitsMargin Limits

For an order entered, the above limits are computed and validated against the max limit available. If any of the limits are violated, the order will not be sent to the exchange by the NeatXS server. The validations for Intraday turnover, MtM and Margin limits happen at the following levels: PRO / Client, TWS and branch. The validation for Short Option Limit happens only for Clients.

2 Intraday Turnover Limits

Intraday turnover is computed for the day’s transactions at order level. This limit is computed as qty * price for all futures and buy options orders and as qty * strike price for sell option orders. The Intraday turnover is computed for every order and checked with the maximum available Intraday turnover for the client / PRO and TWS and Branch. If the used exceeds the max as a result of the new order, the order is rejected.

Intraday turnover is computed as validated as the following levels: PRO / Client, TWS, Branch

3 Short Option Limits

The Short Option (SO) limits are applicable for Clients only. This limit is computed only for net sell options positions and open sell option orders. Cover benefit is provided for sell orders if there is a corresponding buy trade. This value is computed as qty * strike price. The short option value so computed for all outstanding sell orders and position is validated against the maximum short option limit set for the client. If the used SO limit is greater than the maximum SO limit as a result of the new order, the order gets rejected.SO limits are also computed for outstanding positions.

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4 Mark To Market (MtM) Limits

MtM limit is computed on every trade and is a combination of realised Profit / loss and notional loss. Notional Profit is ignored for MtM computation. Notional loss is incurred when the buy price is greater than the current market price or when sell price is less than current market price. Realised loss is incurred if the sell average price is less than the buy average price. Computation of MtM occurs on the outstanding position as well as the day’s position.

5 Margin Limits

Margin requirement for F&O segment is based on portfolio margining system similar to the Exchange, with the addition that margin is computed in NeatXS system on an order Level. Since margin computation is on a portfolio level, as soon as a new order request enters the system the portfolio is generated/modified, margin is computed and compared with the maximum available margin.

5.1 Validations for Margin Limits

Deposits are set for client, PRO, TWS and Branch and multipliers are set for margin limit. This defines the maximum margin limit at each level. Multipliers are also defined for closing margin limit to arrive at the maximum closing margin limit. The margin limit is based on portfolio margining system, which provides set-off benefits between contracts with same underlying and between contracts with different calendar months. Due to these set-offs, a cover order (order opposite to an existing open position) may actually increase the margin. The closing margin is used for closing open positions even if it exceeds the original margin limit.For Example: Client A has margin limit of 1,00,000 and closing margin limit of 1,50,000.Suppose the client has 2 trades as:

Contract Qty Individual MarginFUTSTK ACC 31JUL2003 +15000 Rs.50000FUTIDX NIFTY 31JUL2003 -15000 Rs.60000

Due to inter-commodities set off, the portfolio margin is say, Rs.80,000. Now if Client A wants to close position in FUTSTK ACC by selling 15000 contracts, the margin required for the portfolio may be greater than Rs. 1.00 lac say Rs.1,20,000. Since it exceeds the open margin limit of 1,00,000, the order should get rejected. However, since this is a cover order (order to close an existing position), the value will be compared with the closing margin limit and the order will be accepted.

5.2 Components of Margin limits

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The following are the components of margin limit: Portfolio based Margin Net buy Premium Realised loss Exposure limit

A brief explanation of each of the components

5.2.1 Portfolio based Margin

Whenever the User performs any Order or Trade related activity (i.e. entry, modification, and cancellation), Portfolio gets generated/modified for the trades and orders of the client. This Portfolio is sent to the Margin Calculator for calculating the margin using the Risk parameter file received from Exchange on a daily basis.

If the client/proprietary position consists of simple portfolio with no off-setting contracts in futures and options of the same underlying asset it will work like exposure margin. If the client / proprietary position consist of portfolio of off setting contracts in futures and options of the same underlying asset it will give maximum set off for the same contract and the balance set off to the extent possible for other positions in the same underlying. Example for calendar spread If Client A has net buy NIFTY February futures position of 400 units and sell NIFTY March futures position of 400 units, portfolio margin computation will give a full set off and calculate only spread margin.

The margin is computed:(a)For traded position give portfolio based set off for contracts having the same underlying asset (b)For square off orders, set off to the extent of square off will be given while computing margin (c ) For other orders margin will be collected as a separate position till it is traded

Example Portfolio1 This example is based on SPAN parameter file of 5th February 2002Order/Trade BUY/SELL Contract

detailContract Descriptor

Quantity SPAN based Margin for single position (Rs.)

Trade Buy Futures on Nifty Feb expiry

FUTIDX NIFTY 28Feb2002

200 11014.00

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Trade Sell Futures on Nifty March expiry

FUTIDX NIFTY 28Mar2002

200 10834.00

Trade Buy Reliance petro February futures

FUTSTK Relpetro 28feb2002

1000 6060.00

Trade Sell Reliance petro March Futures

FUTSTK Relpetro 28mar2002

1000 6080.00

Combined Portfolio based margin for portfolio 1 will be Rs 3556/-= (calendar spread benefit) as per the SPAN Parameter file. This is provided as the spread margin requirement in the parameter file.

Portfolio 2:

Order/Trade BUY/SELL Contract Detail

Contract Descriptor


Trade Buy Nifty Futures February expiry


200 11014.00

Order Sell Nifty Futures February expiry


200 10738.00

Combined Portfolio based margin for portfolio 2 will be Rs 10738/-

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Portfolio 3:

Order/Trade BUY/SELL Contract Detail

Contract Descriptor


Order Buy Nifty Futures February expiry


200 11014.00

Order Sell Nifty options strike price 1100 Call European

OPTIDX NIFTY 28Feb2002 1100 CE

200 9090.00

Combined Portfolio based margin for portfolio 3 will be Rs. 20104/-

Non-Spread Position Calendar spread benefits are removed for contracts nearing expiry. I.e 3 days before expiration date, the portfolios are separated for the near month contracts and two separate portfolios are created and margin is computed separately.

5.2.2 Net buy Premium For buy option position the intra day net buy premium is computed as margin requirementMargin requirement for options buy contract will be net buy premium. This is computed only for intra day as the net buy premium is expected to be settled on T+1 basis. Net buy premium is computed for both trade level as well as order level. While computing trade level net buy premium, set off is given for any premium receivable by the same client / trader for the same options contract and across options contract. For order level, set off is given if it is a square off order.

Example

Premium values given under are only examples and have no relation to the actual prices prevailing.

Client AOrder/Trade Buy/Sell Contract Detail Contract Descriptor Premium value (+

=sell, -=buy)Trade Buy Nifty options

strike price 1100 Call European Feb expiry


-15000

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Trade Sell Nifty options strike price 1100 Call European Feb expiry


+10000

Trade Sell Nifty options strike price 1200 Call European March expiry

OPTIDX NIFTY 28Mar2002 1200 CE

+12000

Order Buy Nifty options strike price 1200 Call European March expiry


-10000

Net buy premium requirement for Client A 3000

Client B Order/Trade BUY/SELL Contract Detail Contract Descriptor Premium value (+

=sell, -=buy)Trade Sell Nifty options

strike price 1100 Call European Feb expiry


+20000

Trade Buy Nifty options strike price 1100 Call European Feb expiry


-30000

Trade Sell Nifty options strike price 1200 Call European March expiry


+12000

Order Buy Nifty options strike price 1200 Call European March expiry


-10000

Net buy premium requirement for Client B 8000

Total Over all trader level net premium requirement will be sum of proprietary level + individual client net buy premium. In the above case if Client A and Client B belong to the same dealer, the dealer level net buy premium will be (3000+8000)=Rs.11000/-

5.2.3 Realised loss All realized loss made intra day on close out of trade positions in Futures contracts are retained as margin. This is not carried forward as daily mark to market settlement is done for futures position. Open positions will be carried forward at closing price of the

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previous day and current day’s positions are valued at traded price. Realised loss will be computed at every trade confirmation.

Example

Traded position

Contract detail

Closed out quantity

Buy weighted average price

Sell weighted average price

Realised loss

Reliance petro February futures

3000 45 35 -30000

Nifty feb futures

300 1010 1090 Nil

Margin towards realized loss is Rs.30000/-

5.2.4 Exposure limitThis computation is optional. This is an additional margin, which is computed by Exchange on the clearing members as per SEBI circular. Exposure limit can be used to increase the margin requirement over and above the portfolio-based margin. Exposure margin is computed for all futures position and net sell options positions.

This is the additional 2nd line of margin as specified by SEBI. Exposure is computed as net buy value and sell value for futures contracts and net sell value for options contract. Last Traded Contract Price is considered for Futures contracts and Previous Close underlying Price is considered for Options Contracts for arriving at the net values. Exposure into the specified margin% will give the exposure limit. The specified % of the value for margin purpose is parameterized. (SEBI recommended is 3% of the value is considered for margin if the underlying is Index and 5% is considered if the underlying is stock) The Broker has an option to decide whether to calculate and consider Exposure limit as part of the total margin requirement.

Total margin requirement will be a sum of (a) Portfolio based margin(b)Net buy premium+(c)Realised loss for closed out position +(d)Exposure limit [Optional].

This total margin is compared against the margin limit. Maximum Margin Limits (i.e. Deposit * Margin multiplier) have to be entered for the TWS (Trader + All clients attached to him), the trader (Own-Pro) and his clients. Whenever a trader or a Client enters any transaction, the NEATXS system will calculate Margin as per above

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mentioned process and compares with maximum available margin limit of the client/ trader If both the Client and trader margin are sufficient then the transaction will be sent to the Exchange and utilized margin for the client and trader will be updated accordingly. In case the order is a cover order and the maximum margin is fully used, it is additionally validated against closing margin and the order is send through if the portfolio margin is less than the closing margin.

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FAO Risk Management Concept