Value at Risk (VaR) margin

When you buy shares, the money is due a day or two later. In between, the price can fall — and a buyer sitting on a loss may be tempted not to pay. Margin is the upfront deposit that makes walking away expensive.

Not every share carries the same risk of that happening. The workbook's logic is simple: the tendency to default is higher when share prices "vary a lot". A share whose price swings more in both directions has higher volatility, so it gets a higher margin.

The VaR margin is how that is measured. Value at Risk is a statistical technique that estimates the probability of a stock losing value over a period, using its historical prices and volatility. The VaR margin is defined as a multiple of volatility, expressed as a percentage of the stock price.

It is one of three. The margin on equity shares traded on an exchange is imposed daily and is the sum of:

It is refreshed through the day. VaR margin rates are updated at least five times each trading day, to give market participants better information about volatility and risk management.

It must be collected upfront. Members in the cash segment are mandatorily required to collect upfront VaR margins and ELM from clients. SEBI has a penalty structure for short-collection or non-collection and for false reporting — but if the member collects a minimum 20 per cent upfront margin in lieu of VaR margin and ELM, the penalty for short-collection or non-collection is not applicable.

It is part of the member's own cover. A trading member's liquid assets must at all times cover MTM losses, VaR margins, Extreme Loss Margins and base minimum capital.

VaR margin (Rs)          = VaR margin rate (%) × Value of the position
Upfront cash-market margin = VaR margin + Extreme Loss Margin (3.5%)

Illustrative VaR rates; the 3.5 per cent ELM is the workbook's figure. Anita buys Rs 5,00,000 of each of two shares on the same day.

Same rupee purchase, very different margin — entirely because of the VaR component. The ELM is identical.

Why the bigger number makes sense: the workbook's own illustration has a Rs 10,000 purchase whose price falls from Rs 100 to Rs 80 before pay-in, a notional loss of Rs 2,000. A 17 per cent margin (Rs 1,700) would not have covered all of it. A share capable of that kind of move needs a higher VaR rate.

Later that day Volatile Tech's price swings sharply; at the next of the day's five or more updates its VaR rate is raised, and fresh orders need more margin.

Chapter 4 (Secondary Markets), section 4.6.4 "Margins and cross-margining", lists the three cash-segment margins with VaR first, gives the "at least five times each trading day" update rule, and follows with the 20 per cent upfront rule and cross-margining. Section 4.9.1 repeats VaR margins among what a member's liquid assets must cover. Expect "VaR margin is expressed as a multiple of...?" (volatility), the update frequency, and which margin is the same for every stock (ELM, not VaR).

• VaR margin varies by stock; ELM does not. ELM is 3.5 per cent for any stock.
• At least five times a day, not once at the close. The MTM margin is the one computed at the end of the day.
• Multiple of volatility, as a percentage of the stock price — not a fixed rupee amount per share.
• The 20 per cent rule is about penalties. Collecting at least 20 per cent upfront in lieu of VaR and ELM makes the short-collection penalty inapplicable; it is not the VaR rate itself.
• Cash segment. In the derivatives segment the workbook's futures margins are initial and exposure margin.
• Higher volatility → higher default risk → higher margin. Volatility in either direction counts, up as well as down.