MTM Shortfall, Broker Square-Off and Peak Margin Penalty
On 10 June, with the Nifty at 24,100, a client with ₹10.5 lakh of margin collateral (cash plus pledged funds) buys 12 Nifty futures lots at 24,100. The lot size is 25, the contract value is ₹72.3 lakh and the broker's SPAN+exposure requirement is ₹9.6 lakh. At 2:00 p.m. the Nifty is at 23,850 and the broker's volatility file raises the requirement to ₹10.9 lakh. At 3:05 p.m. the Nifty is at 23,600 and the requirement is ₹11.4 lakh; the client has not responded to two margin calls. The broker squares off all 12 lots at 23,580 at 3:10 p.m. The client is charged the loss, brokerage and any exchange penalty. The broker's risk policy says positions are liquidated without further notice once the shortfall exceeds 5% of applicable margin.
1. Compute the mark-to-market at 2:00 p.m. and 3:05 p.m., the available margin and shortfall at each time, and the final realised loss on square-off.
Read the worked answer
At 2:00 p.m.: loss = (24,100 − 23,850) × 25 × 12 = 250 × 300 = ₹75,000. Available margin = ₹10.5 lakh − ₹0.75 lakh = ₹9.75 lakh; requirement ₹10.9 lakh → shortfall ₹1.15 lakh, which is 10.55% of applicable margin.
At 3:05 p.m.: loss = 500 × 300 = ₹1.5 lakh; available = ₹10.5 lakh − ₹1.5 lakh = ₹9.0 lakh; requirement ₹11.4 lakh → shortfall ₹2.4 lakh, or 21.05% of applicable margin.
Square-off at 23,580: total loss = 520 × 300 = ₹1,56,000, plus brokerage and charges. The client's collateral is left at about ₹8.94 lakh with no open position. The broker acted because the shortfall breached its 5% liquidation policy and the client did not meet the calls; the loss belongs to the client, and if it had exceeded the collateral the account would show a debit balance recoverable from the client.
2. Explain the penalty slabs and compute the penalty for the day. Who pays it, and why does the minimum matter?
Read the worked answer
The exchange penalty for margin shortfall is charged as a percentage per day of the shortfall amount: 0.5% for shortfall up to 1% of applicable margin, 1% for shortfall between 1% and 3%, and 5% above 3%, with a minimum of ₹5,000 per instance. It applies to the peak shortfall during the day, not only the end-of-day figure.
At 2:00 p.m. the shortfall is 10.55% of applicable margin → 5% slab → 5% × ₹1.15 lakh = ₹5,750. At 3:05 p.m. the shortfall is 21.05% → 5% × ₹2.4 lakh = ₹12,000. Since the penalty is based on the highest shortfall, the day's penalty is about ₹12,000 (plus any separate EOD computation).
The exchange imposes it on the clearing member, which recovers it from the trading member and then from the client. The minimum matters because even a trivial shortfall of ₹2,000 attracts ₹5,000, so small, brief breaches are disproportionately costly. Note that this penalty is separate from the trading loss and brokerage.
3. What should the client have done at the outset, given a bearish-to-neutral view and ₹10.5 lakh of collateral?
Read the worked answer
Twelve lots consumed ₹9.6 lakh of ₹10.5 lakh - about 91% utilisation - leaving almost no cushion for mark-to-market. A 1% adverse move (241 points) costs ₹72,300, most of the buffer; a 2% move wipes it out. The position was sized as if futures had no daily settlement, which is the core error.
Better alternatives:
- Take 7–8 lots and keep 30–40% of collateral free, or set the position size so that a 3% adverse move is still funded.
- Express the view with long puts or a bear put spread: maximum loss is the premium, there are no daily MTM calls, and the margin is the premium paid.
- Use a protective put against the futures so the mark-to-market loss is capped, though futures margin still applies.
- Predefine a stop and reduce voluntarily before the volatility file raises the requirement, rather than waiting for the broker's forced liquidation at an unknown price.
A neutral view might tempt a short strangle for premium, but that requires far more margin and carries assignment risk - unsuitable for this collateral.