Risk Management, Margins, Settlement and Regulatory Framework
What this domain tests
This domain tests margin mechanics, settlement obligations and the regulatory plumbing behind exchange-traded options. Expect SPAN and exposure margin, upfront margin, position limits, exercise/assignment and physical settlement risk.
Core rules
- Option buyers pay premium in full and have no further margin obligation. Writers post margin: SPAN margin covers worst-case portfolio risk, and exposure margin is added as a buffer.
- Margins are collected upfront from clients; peak margin and client-margin reporting rules prevent brokers from funding positions.
- Index options are cash-settled; stock options are physically settled, so in-the-money long options can lead to delivery obligations and short options to delivery shortages.
- Clearing corporations novate trades and manage counterparty risk. Daily settlement of premium and mark-to-market flows is separate from final expiry settlement.
- Position limits apply at client, trading member and market level, and can force a position to be reduced before expiry.
- SEBI regulates the market; exchanges and clearing corporations enforce contract specifications and margin rules.
Worked example
A trader writes one call with a SPAN margin of ₹9,000 and an exposure margin of ₹3,000, and receives a premium of ₹2,000. The margin blocked is ₹12,000, not ₹10,000, because the premium received does not reduce the margin requirement. If the position moves against the writer, variation-style mark-to-market may not apply to the option premium in the same way as futures, but the writer must still maintain the margin. If the short option is assigned at expiry under physical settlement, the writer must deliver shares; a failure to deliver triggers close-out and penalties. This is why stock option writers must plan for delivery, not just for premium.
Traps
- Assuming the premium received can be used to meet margin.
- Forgetting physical settlement for stock options.
- Confusing SPAN margin with exposure margin, or treating margin as a fixed percentage of notional.