By Abhishek Chinchalkar
In December 2020, SEBI began implementing peak margin reporting in the equity money and F&O, currency F&O, and commodity F&O segments. The move has been carried out in 4 phases of quarterly, 25 % increment, reaching one hundred % by September 2021. This would imply that successful September 1, one hundred % of the total margin would be essential for initiating even intraday positions. While this would have no effect on positional traders, intraday traders would have to spend a significantly greater margin. But it is not all gloom right here as there exist various hedge tactics with which one can avail margin rewards.
Naked positions, such as extended/quick futures and quick alternatives, have limitless dangers and would quickly call for one hundred% margin. However, what if rather of going only extended futures, you also get a place solution getting the very same underlying, quantity, and expiry? Well, in that case, the danger would lessen considerably. This is due to the fact if the underlying declines, the losses that the extended futures position suffers would be offset by the gains that the extended place position tends to make. What we have right here is a hedge (extended place acting as a hedge to extended futures). This method is known as a Protective Put. While acquiring a naked Nifty futures position needs an overnight margin of more than a lac rupees, did you know that hedging it by acquiring a Put solution reduces the total margin by almost two-thirds?
There are various such hedging tactics that could be deployed to reduced the margins for a position. To cite a couple of maintaining Nifty and the July month-to-month contract as reference promoting a 15800CE needs a margin of about Rs 93,000. Furthermore, promoting a naked contact solution exposes one to potentially limitless danger. But what if one simultaneously buys a 15600CE? Well, performing so would not only limit the danger, but it would also reduced the total margin required to just below Rs 30,000 (like the premium of the extended contact). This represents a margin reduction of about 70%! This two-legged method is identified as the Bull Call Spread.
Let us now take a different instance. Selling an ATM 15700CE and 15700PE needs a combined margin of about Rs 1.14 lakh. This method of promoting a Call and a Put getting the very same, ATM strike is identified as Short Straddle. Once initiated, a Short Straddle rewards if the underlying consolidates close to the strike value and volatility shrinks. However, as this method exposes one to limitless danger, if there is an unexpected pickup in volatility and the underlying begins trending sharply, the losses could get catastrophic, if not managed nicely. Such a danger could be lowered by adding wings to the Short Straddle, which is by acquiring an OTM Put and an OTM Call. Let us say we get a 15500PE and a 15900CE. Adding these two legs would not only limit the danger but would also lessen the total margin essential to about Rs 50,000, representing a margin reduction of more than 50%! This 4-legged method is identified as Short Iron Butterfly.
As can be seen from the above, the rewards of a hedging method are two-folds. One is that the general margin essential can lessen substantially, whilst the other is that the danger can also lessen considerably. Having stated that, there are drawbacks as well. By deploying a hedging method, the profit prospective and the probability of profit also tends to lessen. For instance, in case of the Short Straddle method above, the maximum prospective profit of the method is about Rs 17,500 whilst the probability of profit is about 55%. On the other hand, deploying a Short Iron Butterfly above rather of a Short Straddle would reduced the maximum profit to just about Rs 8,000 and the probability of profit to just about 27%. You have to have to take this into consideration.
Hence, there is a trade-off when initiating a hedging method. You have to have to diligently assess the pros and the cons of the method just before deciding to initiate one. These involve hunting at the danger/reward structure of the method, the payoff, your view on the underlying instrument, your expectations of volatility, the probability of profit, the margin essential, and so on.
Concluding….
Despite the unpopularity of SEBI’s peak margin guidelines, retail traders can avail additional leverage due to the lowered margin needs for hedged positions. This is a major boon to traders as it aids them to deploy their trading capital more effectively and enhance the return on capital as well. The lowered margin needs let traders with low capital to diversify their danger across different symbols, tactics, and strike costs.
(Abhishek Chinchalkar is a CMT Charterholder and Head of Education at FYERS. The views expressed are the author’s personal. Please seek the advice of your economic advisor just before investing.)