What are SPAN and exposure margin?

When a person purchases or sells futures or options, their broker collects a sum of money called a Margin. There are two types of margins that your broker collects SPAN margin and the exposure margin. The goal of this margin is to protect against the risk of adverse price movements in the market.

Both Span and Exposure Margins are risk analysis methods. While SPAN margin is the minimum amount needed to be blocked for future and option writing positions in accordance with the exchange rule, exposure margins are blocked after the SPAN cushion for any potential ATM losses. In this article, we'll take a look at what a SPAN and an exposure margin are, and how each of them works.

SPAN Margin

SPAN, or Standard Portfolio Analysis of Risk, is a method for calculating portfolio risk that gets its name from the software used to calculate it (SPAN). The SPAN margin, also known as a VaR margin in Indian stock exchanges, is the minimum margin necessary to make a trade in the market. For F&O strategies, it is calculated using a defined type of portfolio risk analysis. Before placing a purchase, one can calculate their margin from numerous positions with the help of particular tools. The SPAN margin is usually used by F&O traders who already have enough margin to cover any potential losses.

How does the SPAN margin work?

SPAN full form is Standard Portfolio Analysis of Risk. It derives its name from software used to calculate it (SPAN). It is a method to calculate the portfolio risk and also popularly known as VaR margin in the Indian stock market. SPAN margin is the minimum margin required to initiate the trade for the F&O segment. By using the margin calculator provided by ATS, one can calculate the SPAN margin well in advance before they go ahead and place their order.

The SPAN margin is calculated by the system that takes into account the worst intraday movement and it does that by running the calculation of an array of risk factors that are in charge of ascertaining the potential gains and losses for the contract under the array of conditions. Some of the conditions include the change in volatility, changes in price, and expiry of the contract.

SPAN margins differ from security to security, depending upon the nature of the risk that portfolio is carrying. SPAN margin requirement for the single stock will be higher in comparison to the SPAN requirement of the Index. Therefore, we can say there is a general rule of thumb that higher the volatility higher the SPAN, and lower the volatility lower the SPAN.

There are many margin calculators available on the internet, ATS margin calculator being one of them that helps you to calculate the exact SPAN margin required. Many times brokers offer lower upfront charges as an incentive due to risk factors being lower.

Exposure Margin

The exposure margin is applicable over and above the SPAN margin and usually charged at the discretion of the broker. It is also known as additional margin and is collected as an additional layer of security against the broker’s liability that may occur due to erratic price movement in the market. In simple words, the exposure margin is added over and above the SPAN margin depending upon the exposure one undergoes.

One basic rule of calculating exposure margin is that for Index futures contracts, it is limited to 3% of the total value of the contract. For e.g., if the NIFTY future contract is valued at ₹10,00,000 then the exposure margin would be 3% of the value, i.e., 30,000.

The investor must adhere to the total margin requirement (SPAN + exposure) when initiating a futures trade. Once your broker confirms the margin, the entire margin amount will be blocked by the exchange. According to the guidelines enforced in 2018, both margins should be blocked for an overnight position and failure to adhere to this will result in a penalty.

Conclusion

The SPAN and exposure margin are the two most widely used parameters to maintain margin and apart from this, future and option writers should maintain sufficient margin in their account.

While SPAN margin varies based on the risk involved, the exposure margin is likely to remain more or less at the same level. However, brokers might reduce the exposure margin as an incentive for potential customers.