VaR and SPAN margins are related to every position you take in the stock market, especially if you trade in FnOs. But what exactly are they and how can you calculate them?
Here’s everything you need to know.
VaR is a way to measure the risk of a loss. Value-at-risk, or VaR, is a way to measure the downside risk or potential loss of a portfolio or investment over a certain amount of time. It helps analyse and estimate how much the minimum loss can be with a certain amount of confidence. Essentially, it is a number that tells you how risky a portfolio is.
For example, VaR can tell us that an investor can expect to lose at least 2% of the total value of their portfolio on 1 out of every 15 days. So, it helps figure out how much money could be lost, how likely it is to lose that much money, and how long it could take.
Statistical simulations can be used in a number of ways to figure out VaR. The risk management department of a company keeps a close eye on this parameter and tries to make sure that extremely risky trades are not taken.
Margin SPAN
On the equity markets, traders also need to have a certain amount of money set aside as “margin money” to help cover trade losses. But it is hard to guess how much of a margin is needed to cover all the losses if the market shows the worst-case scenario. As a result, the SPAN, which stands for Standardised Portfolio Analysis of Risk, is a standard way for traders to figure out how much margin money they need.
When figuring out margin amounts for every single position, the SPAN system uses complicated algorithms and machine learning techniques. Each margin amount is equal to the most a single account can reasonably lose in a single trading day. It was made by the CME in 1988, and more than 50 exchanges around the world use SPAN as their official way to figure out how much margin they need. This margin is different for each security because each one comes with a different level of risk. For example, the SPAN margin for a single stock will be higher than that for an Index because single stocks are more risky and volatile.
Risk management
Every trader who is successful knows how important it is to manage risk, which is even more important than making money. With the help of VaR and SPAN calculations, a trader can keep a large number of contracts in their portfolio and stay away from serious margin calls.
More brokers and financial institutions are now focusing on better ways to handle risks. Many of them require that, in addition to SPAN margin, which is collected when trades are started, an additional margin called Exposure margin to be collected to protect against liabilities caused by wild swings, rogue trades, or reactions to extreme stress in the market.
Investing is one of the most effective methods to spend your money. When you first begin investing, however, it is always advisable to stick with investment methods that provide great security and assured returns. The majority of early investments are based on a low-risk profile. Their risk appetite increases as they obtain more investment expertise and understanding of the financial market. It helps investors to diversify their assets and invest in financial instruments with higher returns if they have a high risk profile.
While investing can be one of the most effective methods to spend your money, there is a certain amount of risk involved – especially if you don’t use the right tools. At Zebu, a share broker company, we offer the best online trading platform for our investors, while also giving them an added advantage of lowest brokerage for intraday trading.
What Exactly Is a Derivative?
Derivatives are financial contracts between two or more parties that are based on an underlying asset like stocks, commodities, currencies, etc. The value of the derivative is based on the price or value changes of the underlying asset. You can use derivatives to protect a position, guess which way an underlying asset will move, or increase the value of your holdings.
In order to trade derivatives, you must use an exchange or trade over the counter (OTC). Over-the-counter trade is conducted between two private parties without the involvement of a centralised authority. Furthermore, because the contract is signed by two private individuals, it is vulnerable to counterparty risk. The chance, or rather the danger, of one of the parties defaulting on the derivative contract, is referred to as this risk.
The Benefits of Derivatives:
1. Hedging
The greatest approach to protect yourself from a disastrous investment is to use a derivative contract. When you trade derivatives in the stock market, you’re effectively betting on whether the price of a certain stock will rise or decline. As a result, if you suspect that the stocks in which you have invested are losing value, you could get into a derivative contract in which you precisely predict the stock’s value decline. You can profit from your derivatives contract by hedging your stock market losses as the stock price begins to fall.
2. Arbitrage
A commodity or asset is purchased at a low price in one market and then sold at a much higher price in another market in arbitrage trading. Derivatives trading provides an advantage in terms of arbitrage trading, allowing you to profit from price disparities between markets.
3. Managing Market Volatility
You can insulate yourself from the volatility of other asset classes by investing in derivatives. You can, for example, invest in stocks and then get into a derivatives contract with the same underlying asset. It can protect the health of your portfolio because either of the assets can offset the losses of the other.
4. Excellent investment opportunity
While most traders enter the derivatives market to speculate and profit, it is also an excellent place to put any extra money. Without affecting any of your existing underlying equities, your funds will earn additional returns.
Derivatives Market Participants
1. Hedgers
They are the creators, manufacturers, and distributors of the underlying asset, and they typically sign into a derivative contract to reduce their risk. Simply defined, hedgers guarantee that they will receive a preset price for their assets and will not lose money if values fall in the future.
For example, if you own shares in a company that is currently trading at Rs. 1000 and plan to sell them in three months, you don’t want a drop in market prices to depreciate the value of your investment. You also don’t want to miss out on profits if the market increases in value. You can assure that you are profitable regardless of whether the stock price falls or rises by taking a hedging position and paying a small premium.
2. Speculators
These are real traders that try to forecast the future price of commodities based on a variety of criteria and keep track of their prices on a regular basis. If they believe the price of a certain item will rise, they will purchase a derivatives contract for that asset and sell it at expiration to profit. A speculator, for example, will wager that the stock price will not fall in the above example when you got into a derivatives contract to protect yourself against the stock price decreasing. The speculator will earn if the stock price does not decline during the specified period.
3. Margin Traders
Margin traders are investors that trade on a daily basis and make profits and losses solely based on market moves that day. The margin refers to the minimum amount paid by the investor to the broker in order to participate in the derivatives market. These traders don’t purchase and sell with their own money; instead, they borrow the money from a stockbroker as a margin.
4. Arbitrage Traders
Arbitrageurs are traders who acquire securities at a cheaper price in one market and then sell them at a higher price in another. They can essentially profit from pricing differences because they are low-risk.
Conclusion Investing in derivatives, like all other investment tools, demands a thorough grasp of the market and the ability to make decisions only after gaining sufficient knowledge. You can make good money using derivatives if you invest based on knowledge.
As we mentioned earlier, tools are critical for your investment to go smoothly. At Zebu, a share broker company, we offer the best online trading platform for our investors, while also giving them an added advantage of lowest brokerage for intraday trading.
