Equity Derivatives: Carry, Margins and Settlement Style
Equity Derivatives covers futures and options on indices and single stocks: pricing, margining, exercise and settlement. The exam expects you to know which contract is cash-settled and which is physically settled, and how much margin a position actually blocks.
Pricing and contract design
- Futures trade at spot plus cost of carry, less expected dividend yield; at expiry the futures price converges to spot.
- Lot size is set so contract value at introduction falls in the ₹5 lakh–₹10 lakh band.
- Index futures and index options are cash-settled; index options are European, exercisable only at expiry.
- Stock futures and stock options are physically settled, and stock options are European-style.
Margins
- The seller (writer) posts SPAN margin plus exposure margin; the option buyer pays only the premium and posts no margin.
- Positions are marked to market daily: losses are collected and gains paid.
Worked example. A dealer sells one index futures lot with notional value ₹5,00,000. SPAN margin is 8% and exposure margin 3%. Total initial margin = 5,00,000 × (8% + 3%) = ₹55,000. If the index rises and the position loses ₹4,000 on the day, that loss is debited from the margin account and the dealer must restore the margin to ₹55,000 by the next settlement.
Traps. Adding exposure margin twice, or applying SPAN to the premium instead of the notional, is a common slip. Option buyers do not post margins. Intrinsic value is not option price - time value survives until expiry. And physical settlement means a long stock futures position must fund the full contract value, not just the margin.