Alternative Risk Management Framework

Most commodity prices stay comfortably positive. But a few — crude oil most famously — can, in extreme conditions, fall close to zero or even below it, as happened globally with WTI crude in April 2020.

Ordinary margining is not built for that scenario. So SEBI created a separate, stricter framework that switches on automatically when a contract shows the warning signs of this kind of collapse — the Alternative Risk Management Framework.

SEBI, by circular dated 23 February 2021, imposes pre-expiry margins on cash-settled contracts whose underlying is deemed susceptible to near-zero or negative prices. Once activated, pre-expiry margins during the last five trading days before expiry increase by 5% every day — inducing early closure of open positions and reducing delivery or payment default risk on expiry.

The framework activates on any of three triggers: (1) the commodity price falls by more than 50% within 20 trading days, comparing intra-day highest and lowest prices; (2) for internationally referenced contracts, the reference exchange itself introduces negative-price measures; or (3) the price falls to a level equal to or lower than the maximum price movement observed over the Margin Period of Risk (MPOR) in the past 12 months.

Once activated, the margin benefit on spread positions is withdrawn completely, the Bachelier model (rather than the standard model) is applied for theoretical option pricing, and clearing corporations may levy additional, special or concentration margins at their discretion. De-activation happens once the margin requirement under the alternative and regular frameworks has sufficiently converged.

MCX crude oil futures, in a period of extreme oversupply, fall by 55% over an 18 trading-day window, comparing the highest intra-day price to the lowest. This crosses the 50%-in-20-trading-days trigger, and the Alternative Risk Management Framework switches on for that contract.

For the last five trading days before expiry, pre-expiry margin rises by 5% each day — so a trader holding a position paying, say, a base pre-expiry margin of Rs 1,00,000 sees it climb to roughly Rs 1,05,000, then Rs 1,10,250, and onward, compounding daily. Any spread positions this trader was running lose their margin offset entirely, and option pricing on the contract switches to the Bachelier model, which — unlike the standard model — tolerates zero or negative underlying prices.

Chapter 7 (Clearing, Settlement and Risk Management), section 7.11.7, sets out ARMF in full, immediately after the general devolvement margin discussion. Expect a question on the three activation triggers, the 5%-per-day margin increase over the last five trading days, and the fact that spread margin benefit is withdrawn entirely once ARMF is active.

• The 50% fall trigger is measured within 20 trading days, comparing intra-day highs and lows — not a simple close-to-close comparison over a calendar month.
• Spread margin benefit is withdrawn entirely under ARMF, not merely reduced — this is a complete removal, and a frequently tested point.
• The Bachelier model, not the standard Black-76 model, applies to options once ARMF is active — because the standard model cannot handle zero or negative underlying prices.
• ARMF only applies to cash-settled contracts susceptible to near-zero or negative pricing — it is not a general-purpose crisis margin regime for every commodity.