Risk can be defined as the likelihood of incurring losses in investment compared to the expected outcome of returns. Risk management involves identifying and assessing risk and then developing strategies to manage and minimise the same while optimising returns.
Risk Management strategies
Portfolio Diversification: Investors can opt for more than one financial instrument to diversify their portfolios and further diversify investing in financial products of different companies belonging to distinct sectors. A diversified basket may provide a shield if any industry or company moves in an unfavourable direction.
Practice rupee cost-averaging: All you need to do in this approach is to buy shares regularly – some of these shares purchased by you will be cheaper than others. Over the long run, the buy costs will average out, and what will stand out is the growth of these small, compounding investments.
Stop Limit: If in case the market moves in an unfavourable direction than intended, you can cap your losses by placing the following orders with Angel One,
- Stop-Loss Orders
- Robo Orders
Following Market Trends: Many investors believe that following the trend is one of the most important stock market strategies to mitigate investment risk. The difficulty in this strategy is being able to identify the trend because the markets are dynamic and constantly changing
Take Profit: This is the price at which the investor is willing to sell his investment and book profits. This point is beneficial to reduce the risks when the possibility of further price increase is huge. Booking profits on stocks that are nearing their resistance levels after large gains ensures that investors sell these before consolidation occurs and prices begin to decrease.
The margin requirements in various market segments are the following:
1. Value at Risk(VaR)
VaR estimates the risk of loss in investments. It calculates the percentage of an investment you might lose in a set period given the normal market conditions.
A VaR margin has three components:
- period (one day for liquid securities)
- confidence level (99%)
- loss (amount or percentage)
VaR margin intends to cover the highest loss that one can encounter on 99% of the days (99% Value at Risk).
For example, a security with a 20% VaR margin requirement implies a possibility of a 20% loss in the value of the stock in one day, given the confidence is 99%. If the trade value of a security is ₹1,00,000, 20% VaR would be ₹20,000.
The VaR margin is collected on an upfront basis at the beginning and varies from scrip to scrip.
2. Extreme Loss Margin
The Extreme Loss Margin aims at covering the losses that could occur outside the coverage of VaR margins.
The Extreme Loss Margin for any stock is higher than 1.5 times the standard deviation of daily logarithmic returns of the stock price in the last six months or 5% of the position’s value.
As per the regulatory guidelines, Angel One assumes a margin requirement at X% or 20%, whichever is higher.
For instance, if (VaR+ELM)=17%, Angel One assumes the margin requirement as 20%.
3. Mark to Market(MTM) margin
MTM is calculated at the end of the day on all open positions by comparing the transaction price with the stock’s closing price for the day.
For instance, if you buy 100 shares of ‘X’ at ₹100 at 11 AM on a trading day ‘T’ and if the closing price of the shares on that day happens to be ₹75, then you will face a notional loss of ₹2500 on your buy position. This loss is termed as MTM loss and is payable on ‘T+1’ day before the opening of the trade.
4. Initial/SPAN margin
The initial margin for the F&O segment is calculated on a portfolio (a collection of futures and option positions) based approach. The margin calculation is carried out using software called – SPAN (Standard Portfolio Analysis of Risk).
SPAN generates about 16 different scenarios by assuming different values to the price and volatility. For each of these scenarios, the possible loss that the portfolio would suffer is calculated. The initial margin required to be paid by the investor would be equal to the highest loss the portfolio would suffer in any of the scenarios considered. The margin is monitored and collected at the time of placing the buy/sell order.
5. Exposure margin
In addition to the Initial/SPAN margin, the exposure margin is also collected in the F&O segment to protect the positions.
- Exposure margins regarding index futures and index option sell positions are 3% of the notional value.
- For futures on individual securities and sell positions in options on individual securities, the exposure margin is higher at 5% or 1.5 standard deviations of the logarithmic returns of the stock (in the underlying cash market) over the last six months period. It is applied to the notional value of a position.
Auto Square Offs
Closing of the open positions either by broker or trader is termed as Square Off. Auto Square Off is when the brokers square off an open position on meeting certain pre-requisite conditions as per their Risk Policy. Angel One provides the following Auto Square Off facilities:
1. Intraday Position Square Off
All the intraday positions have to be squared off on the same trading day before the close of market hours. If you fail to close the open position, it will be automatically squared off as per the below schedule for different segments.
|Segment||Square off time|
|Capital And Derivative Segments of Equity market||Between 3:15 pm and closure of the market|
|Commodity Segments||Between 11:15 PM and market closure when the market closes at 11:30 PM
Between 11:30 PM and market closure when the market closes at 11:55 PM
|Currency and Agro Commodities||Between 4:45 PM and closure of the market|
However, if the market loss on “Intraday” positions reaches 80% (the trigger) of the total funds available, the “Intraday” positions would be closed out on the best effort basis. Before that, Angel One will send you an alert message to add the required margin when your MTM losses approach the limit (80%), informing you of the close-out.
Note: All the square offs will happen based on available quantity in the market and breach of market circuit filter.
2. F&O Delivery Margin Shortfall Square Off
Suppose you have purchased security of Company’ X’ at a strike price of ₹2100. Due to market movements, the settlement price declared on the expiry day by the exchange is ₹2130. It means the option you bought is In-the-Money (ITM) option, i.e., the current stock price is more than the strike price and will be squared off (on the best effort basis) as a CTM contract by Angel One.
CTM contract: Three strike prices above and below the settlement price are known as CTM contracts. In our example, the settlement price is ₹2130. Hence call options with a strike price of ₹2120, ₹2110, ₹2100 and put options with strike price ₹2140, ₹2150, ₹2160 are known as CTM contracts.
However, if you don’t maintain a sufficient delivery margin in your account, even if your position enters a CTM contract, it will be squared off by Angel One on the day of expiry.
Note: All squaring-offs depend on available quantity in the market and breach of market circuit filter.
3. Risk Square off / Projected Risk Square off
It is a potential risk of an investor in the occurrence of adverse market conditions during the day.
To avoid the projected square off, you are expected to maintain at least 50% of the VaR (Angel One stipulated margin). Otherwise, you will be qualified for a Projected Risk Square off, and an intimation would be triggered.
Traders are given a ‘T’ days period to clear the margin shortfall amount (outstanding dues), failing which the deals will be squared off on a best effort basis on the following trading day (T+1).
Note: All square-offs happen based on available quantity in the market and breach of market circuit filter.
4. Ageing Debit Square Off (T+ 7)
You should ensure timely provision of funds to Angel One to meet exchange obligations. If you fail to do so, Angel One reserves the right to close the positions/sell securities to the extent of ledger debit and/or to the limit of margin obligations.
All trades executed on Monday are available for a square off on the best effort basis next Wednesday, i.e. on T+7 days, where T indicates Trading day. It means that if traders fail to meet the margin requirements by T+6 days, Angel One will liquidate securities to the extent of ledger debit and/or margin obligations.
Note: All square-offs happen to available quantities in the market and breach of market circuit filter.
5. Margin Trading Facility (MTF) square-off
- While purchasing stocks under Margin Trade Facility (MTF), you should keep the applicable minimum margin or any increased margin available.
- In case of a margin shortfall, you have to pay the shortage immediately on receiving demand (margin call) on T day and in any case not later than 11.00 PM on the trading day following the day of making the margin call. If you fail to do so, Angel One will reserve the right to liquidate the funded shares and/or collateral shares to recover the dues outstanding in your MTF account.
Note: All the square offs will be subjected to available quantity in the market and breach of market circuit filter.
Risk management on alpha and active basis
If market or systematic risk were the sole determining factor, the return on a portfolio would always equal the beta-adjusted market return (beta being the standard passive risk of the market, as opposed to alpha that is the operational risk that fluctuates). Naturally, this is not true: Returns fluctuate due to a variety of unconnected reasons. Investment managers who pursue an active approach accept additional risks to earn a premium above the market’s performance. Active strategies employ stock, sector, nation selection, fundamental analysis, position-sizing, and technical analysis. Active managers are always on the lookout for an alpha or excess return.
The Risk Cost
In general, the more an active fund and its managers demonstrate their ability to generate alpha, the greater the fees associated with exposure to those higher-alpha strategies. The pricing differential between passive and active methods (or beta and alpha risk, respectively) incentivises many investors to segregate these risks (e.g., paying lower fees for the beta risk assumed and concentrating their more expensive exposures on specifically defined alpha opportunities). This is commonly referred to as portable alpha, which refers to the concept that the alpha component of a total return is distinct from the beta component.
Financial planners will often ask you about your risk appetite to suggest suitable investments according to your risk profile.
Defining Risk Tolerance
In simple terms, it defines how much risk you are ready to withstand when your portfolio is performing poorly. If your outlook regarding risk is conservative, you will choose low-risk investment options. Understanding risk tolerance helps you decide the game plan.
Factors in Risk Tolerance
Goals: Before you even begin a financial journey, you need a clear understanding of how much wealth you want to build and accordingly build the investment game plan.
Timeline: Generally, the longer you stay invested, your risk-taking abilities increase along with the chances to optimise profit.
Net worth and disposable income: For high net-worth individuals with more disposable income, risk tolerance may remain unaffected even with advanced age.
Portfolio size: Usually, with a larger portfolio, you have more cushion when the price drops and also greater diversification opportunities.
Personal preference: Some investors, by nature, are aggressive risk-takers or risk-averse.
Deciding Risk Tolerance
Advisors use questionnaires and surveys to decode your risk abilities. Future earning capacity and time horizon also factor in risk evaluation. Usually, when you have financial stability or income-generating assets, your risk tolerance increases.
Based on risk appetite, investors are divided into categories such as conservative, moderate, and aggressive.
Risk management strategies are a shield to protect investors and brokers from incurring losses due to market fluctuations. To learn more about the Risk Management Policy of Angel One, click here.