It will still be nice to have you keep that 10% additional margin. Remember that your broker still has to pay it from their pocket, even if you are not paying it. If the brokers bear the cost and this keeps going up, business models might have to change.
What is paid to the exchanges, they won’t refund for sure. Brokers are asking for penalties to be lesser in the future. Some of these penalties aren’t really in the broker’s control either. I am sharing a part of the recent note that I sent to exchanges.
Margins on short option positions
When a customer holds a futures position and has a marked-to-market loss, the customer gets time till the next trading day to fund the losses. There is no margin penalty on the trading day, and a penalty is levied only if the customer doesn’t bring the MTM loss on the next day.
In a short-option position, there is no MTM loss when the market moves against the customer, but the margin required to hold the position goes up. An upfront margin penalty is charged if the customer doesn’t have sufficient margins to hold this position, both for intraday peak and end of the day and on the trading day itself.
So, for example, on Monday, 29th Aug, the beginning of day (BOD) margin to short Banknifty 39000 puts was ~ Rs 1.5lks. As the markets went lower, the margin increased. Both for peak and the end of the day, the margin required was ~ Rs 1.65lks. A penalty was charged since the margin went up.
If we allow until T+1 day to bring in any loss for the futures position, customers who hold short options should also be allowed to fund the increased margins by the next trading day. In terms of risk, short options carry lower risk than futures.
To cover this issue, we charge an additional margin of between 3% and 5% over and above whatever the exchanges ask. It works for most days when markets aren’t trending either up or down, but on days the market moves significantly in one direction, no additional margin is enough to ensure the customer isn’t in a situation where a penalty is levied. For example, on a day like last Monday, we would have had to ask for an additional 15%; on a more volatile day, it could be as much as 50% and over. This is one of those impossible to comply with types of regulation, and I hope something can be done about it.
Hedged positions
The biggest reason for the penalties is when customers who hold a bunch of F&O positions first exit long options that increase the risk of the portfolio, and hence the margins increase post-exit. There is a margin penalty if customers don’t have sufficient free cash post exit of a position.
To solve this problem, the risk management system (RMS) should not allow the exit of any position if the post-exit margin required for the portfolio goes up and if the customer doesn’t have sufficient free funds. Until now, no RMS globally that I know of has the facility to do this check while a customer is exiting positions. This is a complex technological problem, given that this simulating post-exit portfolio margin has to be done in the order path. We are working on launching our in-house RMS with this feature. Even the vendors are trying to build out this feature. But until that happens, which can be upwards of a year or even more for the entire industry, all brokerage firms are like sitting ducks and have no way to avoid this penalty.
I am not requesting any changes to this, as the penalty will force brokers to push for this technological change. But I request you to consider changing how margin penalties are charged today. The short-margin penalty framework was mostly thought for the end-of-the-day margins era, but now the same penalty is being charged on peak margins as well, which potentially, for reasons mentioned above, increases the number of instances almost exponentially.
Margin penalty is 0.5% for shortfall amounts lesser than Rs 1lk and 1% above Rs 1lk. This isn’t too bad. But the penalties(NSE) go up significantly when
- If short/non-collection of margins for a client continues for more than 3 consecutive days, then penalty of 5% of the shortfall amount shall be levied for each day of continued shortfall beyond the 3rd day of shortfall.
- If short/non-collection of margins for a client takes place for more than 5 days in a month, then penalty of 5% of the shortfall amount shall be levied for each day, during the month, beyond the 5th day of shortfall.
The above penalty that has to be paid by the broker increases the risk exponentially for the broker. Also, since the penalty has to be paid by the broker, the customer disregards any notification to make sure long options are not exited in hedged positions or if short option positions are going against the customer to bring additional margins on the same day. Well-capitalised brokers like us would have the wherewithal to cover the penalty, but this could get large enough to hurt small and medium brokers, large enough to find loopholes to avoid or fund this, leading to larger issues.