HOW DOES CROSS-MARGIN AGREEMENT WORKS

WHAT IS CROSS MARGINING?

Margin means to pay cash as collateral to cover credit risk, when buying or selling futures or writing
options. So when a trader wants to take a position in futures or write options, he has to deposit certain
percentage of the total exposure of contract as cash. This deposit of cash with broker is called margin.
Assuming a trader wants to buy NIFTY 50 APRIL FUTURES where the total exposure is 8500 x 75 Qty =
637, 500, he has to deposit cash of roughly 63,000 (10%) as margin. Now to calculate what margin you
need, NSE would calculate the net open position in every stock or index, by offsetting, for instance,
futures along with options.

Cross-margining, which is also known as “spread margin", allows market participants to reduce the total
margin payment required, if they are taking two mutually offsetting positions. Cross margining is
concept whereby a trader can transfer excess margin from one account to another account to satisfy
margin maintenance requirements to offset positions.

In simple terms, a HDFC Bank future position at 850 (Lot size 500) could need a 20% margin, or Rs 170 x
500 = 85000 per lot. But if a trader also buys a put option on HDFC Bank at strike price say 900, then the
downside is protected, so the margin requirements can be brought down substantially. Exchange will
offset the two and ask for a lower margin, of say Rs. 40,000 per lot.

Margining offsets can also be between futures. If you’re Long April futures and Short May futures in
HDFC Bank, the net margin will be considerable lesser than if a trader had either of those positions in
isolation.

With cross margining, positions can be offset between segments. The “cash” segment – where a
trader/investor own stocks in demat account – can now be offset against corresponding futures. For
instance, Mr. K might own 250 shares of HDFC Bank. And then, Mr. K might write a call option on HDFC
Bank at Rs. 900, on the basis that it won’t cross Rs. 900 this month, and he earns some premium from
the position.

If cross-margining weren’t allowed, Mr. K would have to provide more money against the call option.
This is inefficient because there is no real reason for that margin. Mr. K already own the shares, and thus
if the stock goes up beyond Rs. 900, shares can be sold to provide cash. Below 900 there is no risk to call
option position (since the option will expire worthless).

With cross margining, Mr. K can provide HDFC Bank shares as margin, which is a “cash segment”
position, against the call option which is a “derivatives segment” position.

Cross margining is also allowed for stocks against stock futures/options, and stocks against index
futures/options. If you’re long Reliance and HDFC Bank, and short the Nifty, the stock position offsets
nearly 20% of the Nifty position (as these two stocks have approx 20% weights in Nifty), so margins will
be that much lesser.

HOW DOES CROSS MARGINING HELPS?

 Due to cross margining, keeping cash as margin is substantially reduced.

 It increases the trading capacity. Since the margin is considerably reduced, a trader can increase
his position in trading with the extra margin saved due to cross margining mechanism.

 Certain strategies like “covered call” and “protective put” can be executed more efficiently since
the trader does not have to put more cash as he is already holding stocks in the demat account.
These stocks will act as a margin and hence trader can get extra “income” by writing call/put
option.

FEATURES OF CROSS MARGINING

 Cross-margining benefit is available between index futures and underlying constituents/futures,

stock futures and underlying stocks; ETFs and their underlying constituents and highly correlated
indices.

 Cross margining benefit is available to all categories of market participants.

CROSS MARGIN AGREEMENTS

1. Cross Margin agreements can be entered between

1. Exchanges (Like NSE and BSE)

2. Clearing member and trading member
3. Member, custodian and Constituent
4. Stock broker and client

2. The parties are bound by the orders, provisions or circulars of the capital market regulator of a
country (In India SEBI).

3. The parties are also bound by the Rules, Byelaws, Regulations and Circulars issued from time to
time by clearing house(s) including provisions with respect to cross margining.

4. The parties are subjected to terms and conditions prescribed by clearing house(s).

5. In the event of default by a any of the parties in agreement , whose clients have availed cross
margining benefit, clearing house(s) may:

1. Hold the positions in the cross margin account till expiry in its own name.
2. Liquidate the positions / collateral in either segment and use the proceeds to meet
the default obligation in the other segment.

3. In addition to the foregoing provisions, take such other risk containment measures
or disciplinary action as it may deem fit and appropriate in this regard.