SPAN

A trader holding a long future and a protective put does not have two risks. They have one, smaller, combined risk. A margin system that looks at each position on its own cannot see that, and overcharges.

SPAN looks at the portfolio instead. It builds a set of hypothetical futures — what if the underlying moves this far and volatility moves that far — revalues every position the client holds under each of them, and charges the worst single outcome as initial margin.

That is the whole idea: margin is not the sum of the risks of the positions, it is the risk of the portfolio.

SPAN is a product of the Chicago Mercantile Exchange, used by leading exchanges worldwide and adopted by Indian clearing corporations for real-time initial margin computation.

It starts from value at risk — the maximum likely price change over a given horizon at a given confidence level — and improves on it in two ways. First, it generates 16 "what-if" scenarios of price and volatility change rather than relying on a single statistical number. Second, and more important, it computes margin for the entire portfolio of an investor rather than position by position, taking an integrated view of positions in options and futures on the same underlying across different maturities.

The calibration is set by SEBI: initial margin requirements are based on 99 per cent value at risk over a time horizon determined by the Margin Period of Risk of each product, which clearing corporations must estimate product by product subject to a minimum of 2 days.

Computation happens in two stages — the portfolio is valued under the sixteen scenarios to produce Scenario Contract Values, and those are then applied to actual positions in real time. To keep them current, Scenario Contract Values must be updated at least five times a day: the previous day's closing price at the start of trading, then at 11:00 a.m., 12:30 p.m. and 2:00 p.m., and again at the end of the session.

SPAN margin is only one component of initial margin. Initial margin also includes margin on consolidated crystallised obligation, delivery margins, and any other additional margin the clearing corporation specifies.

Initial margin = SPAN margin
               + Margin on consolidated crystallised obligation
               + Delivery margins
               + Other additional margins specified by the CC

SPAN margin    = Worst loss of the portfolio across 16 price/volatility scenarios,
                 calibrated to 99% VaR over the product's Margin Period of Risk
                 (MPOR, minimum 2 days)

Calendar spread charge = 1.75% of the far month contract  (index derivatives)
                       = 2.20% of the far month contract  (single stock derivatives)

A client runs a calendar spread in a single stock — long the near-month future, short the far-month future — with a far-month contract value of Rs 40 lakh.

If each leg were margined on its own:
  Long  near month, notional Rs 40 lakh, IM at (say) 16%   = Rs 6.40 lakh
  Short far  month, notional Rs 40 lakh, IM at (say) 16%   = Rs 6.40 lakh
  Naive total                                              = Rs 12.80 lakh

Under SPAN, the legs largely offset. What is left is the
spread risk, charged as the calendar spread charge:
  Single stock derivatives: 2.2% of the far month contract
  = 2.2% x Rs 40,00,000                                    = Rs 88,000

The percentages on the naive legs above are illustrative; the 2.2 per cent calendar spread charge is the workbook's own figure, as is 1.75 per cent for index derivatives.

The trap is the exit. SEBI has removed the calendar spread benefit on the day of expiry, because a contract expiring that day can move very differently from one expiring later. Our client wakes up on expiry day to find the offset gone and the two legs margined separately — a margin call of several lakh rupees on a position they did not change.

Chapter 4 (Risk Management, section 4.1.2.1) is where SPAN lives, alongside Margin Period of Risk, calendar spread charges, additional margins and cross margining. The reliably repeated facts are 16 scenarios, 99 per cent VaR, MPOR minimum 2 days, at least 5 updates a day, and the two calendar spread percentages. Given 25 per cent negative marking against a 50 per cent pass mark, these are worth learning as exact numbers rather than approximations.

• Sixteen scenarios, not fifteen or twenty. And they are scenarios of price and volatility change, not of price alone.
• SPAN margin is not the whole initial margin. Delivery margins and margin on consolidated crystallised obligation sit alongside it. Extreme Loss Margin is separate again.
• MPOR has a floor of 2 days, estimated per product on liquidity. It is not a fixed 2 days for everything.
• Five updates a day is a minimum, and the fixed times are 11:00 a.m., 12:30 p.m. and 2:00 p.m., bracketed by the previous close at the start and the closing price at the end.
• Calendar spread benefit disappears on expiry day. Positions that looked cheap to carry all month suddenly are not.
• Initial margin for client positions is netted at individual client level and grossed across clients at member level, with no set-off between clients — and no set-off between client and proprietary positions either.
• Index is 1.75 per cent and single stock is 2.2 per cent. The riskier, less diversified single stock carries the higher charge; if you can remember which way round that logic runs you do not have to memorise the pair.