Yet another interesting concept that every novice in stock markets should be familiar with. Margins dictate what amount you are supposed to pay to the exchange outright as an assurance that you will not default. When you purchase a stock's share, you dont pay the amount immediately. You pay your broker the next day (t+1) and your broker is supposed to pay to the exchange the day after that (t+2). So, if you bought the stock at Rs 25 and its price fell to Rs 20 by EOD that day, then you are in a loss of Rs 5 on each stock. You might thus choose to default and not pay to your broker. Due to such scenarios, the concept of margins is introduced. In laymans terms, you are supposed to pay some money outright to your broker when you make a purchse as a security. This is called margin. In the event of you defaulting, this money will be used by broker to pay up for the notional loss on that scrip incurred.

Volatility: In simple terms, it means how often does the price of a stock change. We can calculate volatility of a stock as follows -

Note down the price of the stock for last 30 days in first column. The second column values are calculated as LN(curr_days_close_price / prev_days_close_price) where, LN = natural logarithm. Find the standard deviation across all the values in the second column. This standard deviation is called historical volatility of that stock. This is one measure of volatility.

There can be different types of margins that are enforced by the exchange -

1. Security VaR : It can be defined as - "With 99% confidence, the total loss suffered on a particular stock over one days time period will not be more than 5%". So in this, VaR = 5%. Thus, it has three componenets- a confidence level, a time period, and a percentage value indicating loss. NSE gives VaR values for its listed stocks with a confidence value of 99% over one day time frame. The actual VaR rate that you are charged is calculated using this Security VaR and the stocks price. (This is done based on a fixed formula which i am too bored to describe :-P).

2. Extreme Loss Margin: This can be given by max ((1.5 * historical_volatility), (5% of your position)). This aims at covering losses occuring outside VaR margin. This value if calculated at the start of every month by calculating rolling data for past 6 months.

The actual margin that you are charged is a sum of these two.

## Tuesday, July 13, 2010

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I actually understood this one! niceee! :-)

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