Different Types of Margin Explained

Getting acquainted with some critical stock market terms, including different types of margins, will help you move in the market easily. Before learning different types of margins, you must understand what margin is first. Margin means borrowing money from a broker to buy an investment. It is entirely different from the total value of the investment and the loan amount. You may be wondering now how many types of margins there are. Gross Exposure Margin, Daily/Initial Margin, Special Margin, Mark-to-Market Margin, Volatility Margin and Ad-hoc Margin are the six different types of margins. Let’s understand each type of margin in this article.

Key Highlights

• Margin refers to borrowing money from a broker to buy an investment.

• The six different types of margins are gross exposure margin, daily/initial margin, special margin, mark-to-market margin, volatility margin and ad-hoc margin.

• Margin ensures that enough resources are available to traders.

Types of Margins

Here are various types of margins in the stock market.

Gross Exposure Margin

This type of margin is the total value of all your open positions in the market. It helps to control the overall portfolio risk by limiting the total exposure. Brokers will have to collect security as cash or bank guarantees to avoid default on the positions a trader goes for on the given day.

Daily/Initial Margin

At each trading day’s end, brokers will collect the margin payable against open positions from their users. These open positions can be on the buy side or the sell side. Daily margins are helpful to avoid eventualities taking between two trading days. While trading in derivatives, you must put an initial margin before opening the Futures transaction’s day when buying or selling. The calculation of margins depends on the changes that occur in it. 

Special Margin

You need to pay exceptional margins on stocks with abnormal share prices or volume movement. It is almost like a surveillance measure used to check out speculative activity in a particular script. For example, at the Bombay Stock Exchange (BSE), there will be a margin of 25% or 50%. But, essentially, it is dependent upon the sharp movement of share price or volume. 

Mark to Market Margin

Mark-to-market margin means the difference you need to pay whether you buy or sell. For example, you need to make payments when there is a plunge in the market price below the transaction price or an increase above the transaction price. The calculation of margins depends on the difference between a particular day’s close and the previous day’s close. You can find it in F&O mostly. 

Volatility Margin

The volatility margin helps understand abnormal intraday fluctuations in a scrip. You must honor your commitments during tremendous volatility in share prices when buying or selling. The calculation of the volatility margin depends upon the difference between the highest and lowest prices over a 45-day transaction cycle, where the lowest price will be compared. You need to pay the margin as cash or shares in your Demat account.

Ad-hoc Margin

The Ad-hoc margin is a SEBI-prescribed margin. Brokers have to pay Ad-hoc margins for significant positions overall. They apply to certain low-priced stocks that come with illiquidity.

The Logic of Charging Margins in Equity Trades

The margin system ensures that enough resources are available for traders. With enough resources, you can fulfil your obligations. The prices of futures are volatile. There is a possibility of more than one margin call each day. It is the responsibility of the futures exchange to decide margin requirements. There will be an increase in margin requirements when the volatile market prices. Thus, it is like dealing with the added risk of daily price fluctuations in the market. The adjustment of margin requirements to trade lower and reflect the lower risk during a market’s volatility fall. 

Interest and Penalty on Margins

Margin interest is the interest applicable on loans between you and your broker, depending upon your investments. For example, a short sale of stock requires borrowing first on margin. After that, you have to sell it to a buyer. Buying on margin allows you to use leverage strategies, which means buying more shares than with limited cash. 

Although the accumulation of margin interest happens daily, you must pay for it monthly. To compute the daily interest rate, the settled margin debit balance is multiplied by the annual interest rate while dividing the outcome by 360. The debit balance amount helps you know the annual interest rate on a specific day. 

SEBI imposes a margin shortfall penalty on a trade without the following factors.

• Sufficient margin (SPAN & Exposure for the FnO segment, while VAR+ELM+Adhoc for the Equity segment)
• Net buy premium
• Physical delivery margins
• marked-to-market losses, depending on the exchange

The penalty will be in the form of a percentage of the shortfall amount. It can be reflected in the narration “Being CFX/F&O/MCX/Equity Margin Penalty Charges for the Trade Date”. You can see it in your ledger. 

Conclusion

Knowing different types of margins in the stock market is important for any investors seeking to understand the complexities of trading. Different types of margins include gross exposure margin, daily/initial margin, special margin, mark to market margin, volatility margin, and ad-hoc margin. Each type of margin serves a different purpose in managing risk and ensuring market stability. By understanding these margin types, traders can better prepare for potential market fluctuations. Thus, enabling traders to make informed decisions and maintain compliance with regulatory requirements.

FAQs on Types of Margin