Expiry-day calendar spread: when the margin benefit disappears
A proprietary trading firm clears through a clearing member. On the morning of expiry, the firm holds 400 lots long Nifty 24,800 calls expiring that day and 400 lots short Nifty 25,200 calls expiring next week. Lot size is 25. Nifty spot is 24,795. The near call is quoted at ₹12 and the far call at ₹96. The clearing member's margin model gives the following: for the short far call alone, SPAN margin is 5.4% of notional and exposure margin is 3.0%; for the recognised calendar spread, SPAN margin is 2.1% and exposure margin remains 3.0%. The firm has posted collateral of ₹1.35 crore, comprising cash and a bank guarantee. Peak margin is computed on four intraday snapshots and must be 100% of the required margin. At 1:30 p.m., the near calls expire worthless and the spread benefit lapses. The firm's operations team expects no additional funding until the next morning.
1. Compute the margin requirement before and after the spread benefit lapses, and quantify the excess or shortfall at 1:30 p.m.
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The short leg is 400 lots × 25 = 10,000 units of the 25,200 call. Short notional:
10,000 × 25,200 = ₹25,20,00,000, i.e. ₹25.20 crore.
With the spread benefit:
- SPAN: 2.1% × 25.20 crore = ₹0.5292 crore
- Exposure: 3.0% × 25.20 crore = ₹0.7560 crore
- Total: ₹1.2852 crore
Collateral is ₹1.35 crore, so the excess is ₹1.35 − ₹1.2852 = ₹0.0648 crore, or about ₹6.48 lakh.
After the near calls expire and the spread benefit lapses:
- SPAN: 5.4% × 25.20 crore = ₹1.3608 crore
- Exposure: 3.0% × 25.20 crore = ₹0.7560 crore
- Total: ₹2.1168 crore
Shortfall = ₹2.1168 − ₹1.35 = ₹0.7668 crore, or about ₹76.68 lakh.
The key point is that the firm was adequately collateralised on a spread basis but is materially under-collateralised once the long near leg disappears. The expiry itself does not create the loss; it removes the hedge that justified the lower margin.
2. Explain the clearing and settlement consequences of the ₹76.68 lakh shortfall at the 1:30 p.m. peak-margin snapshot.
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Peak margin is not an end-of-day-only concept. The clearing member must maintain 100% of the required margin at the exchange's intraday snapshots. A shortfall at 1:30 p.m. can trigger a margin penalty and, if not cured, forced reduction or close-out of the position.
The clearing member is primarily liable to the clearing corporation. It cannot tell the clearing corporation that the client or proprietary firm failed to fund; the member must meet the obligation and then recover from the firm. Practically, the member may:
- Issue an immediate margin call and demand cash or a bank guarantee by the exchange's cut-off.
- Square off part of the short far call to reduce notional and margin.
- Use the firm's collateral, and if that is insufficient, use its own resources and charge the firm.
The firm also faces penalty exposure at the prescribed rate on the shortfall, possible withdrawal of position limits or trading restrictions, and reputational damage with the clearing member. If the position is closed out in a rising market, the close-out cost may be worse than the original margin shortfall. The operations team's assumption of 'no funding until tomorrow' is therefore not acceptable.
3. Recommend concrete actions the firm and clearing member should take before 1:30 p.m. Evaluate at least two alternatives.
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The firm should act before the spread benefit lapses, not after. Two viable alternatives are:
- Reduce the short far-call position. Buying back, say, 150 lots reduces short notional by 150 × 25 × 25,200 = ₹9.45 crore. At the standalone margin rate of 8.4% (5.4% SPAN + 3.0% exposure), that releases about ₹79.4 lakh of margin, roughly covering the projected shortfall. The cost is the option premium and giving up some premium income, but it is the cleanest way to restore compliance without new funding.
- Re-establish a recognised spread. The firm could buy a further out-of-the-money call in the same expiry as the short 25,200 call, converting the naked short into a vertical spread. A 25,700 call would cap tail risk and may attract lower SPAN margin, but the exposure margin and the cost of the long call must be checked. A new calendar spread using a later expiry is also possible, but it may not receive the same benefit on expiry day.
A third option is to deposit additional collateral of at least ₹77 lakh in cash or an acceptable bank guarantee before the snapshot. The firm should compare the cost of buying back options, the cost of a new hedge, and the funding cost of collateral. It should also pre-agree the cure plan with the clearing member and document the instruction. Doing nothing and hoping the 1:30 p.m. snapshot is not binding is not a risk control.