Risk containment measures for Option on Indices

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....es Contracts. SEBI has setup a ' Technical Group' headed by Prof. J.R Varma to prescribe risk containment measures for new derivative products. The group has recommended the introduction of Exchange traded Options on Indices which is also in conformity with the sequence of introduction of derivative products recommended by Dr. L.C Gupta Committee. The 'Technical Group' has recommended the risk containment measure for Exchange traded Options on Indices. While SEBI would not mandate any particular risk management product, the framework shall be consistent with the risk management guidelines mandated by the L. C. Gupta Committee. The Exchanges are free to decide whether they want to adopt any of the risk management models available globa....

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....rtfolio based margining approach shall be adopted which will takes an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in index futures and index options contracts. The parameters for such a model should include- A) Worst Scenario Loss The worst case loss of a portfolio would be calculated by valuing the portfolio under several scenarios of changes in the index and changes in the volatility of the index. The scenarios to be used for this purpose would be: Risk Scenario Number: Price Move in Multiples of Price Range Volatility Move in Multiples of Volatility Range Fraction of Loss to be Considered 1. 0 +1 100% 2. 0 -1 100%....

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....in each month. Thus, a portfolio consisting of a near month option with a delta of 100 and a far month option with a delta of - 100 would bear a spread charge equal to the spread charge for a portfolio which is long 100 near month futures and short 100 far month futures. The Calendar Spread Margin would be charged in addition to the Worst Scenario Loss of the portfolio. ii. As in the index futures market, a calendar spread would be treated as a naked position in the far month contract as the near month contract approaches expiry. Currently, in the index futures market, this is done in gradual steps over five trading days. For the sake of computational ease, it is now decided that when options are introduced, the gradual steps would be el....

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.... from the available Liquid Net Worth on a real time basis. G) Cash Settlement of Futures Mark to Market The mark to market gains/losses for index futures position shall continue to be settled in Cash. H) Position Limits The existing position limits in the index futures market shall be applicable to index options also on the basis of notional value. I) Real Time Computation The computation of Worst Scenario Loss has two components. The first is the valuation of each option contract under sixteen scenarios using an appropriate option pricing model. The second is the application of these Scenario Contract Values to the actual positions in a portfolio to compute the portfolio values and the Worst Scenario Loss. For computation....