Deep Out of The Money (OTM) Contracts Margin Changes-NSE Circular

Attention Deep Out of The Money (OTMs) traders, as new NSE CIRCULAR is been issued effective from October 18, 2019. In case you are trading in deep out-of-the money options, then you have to pay an extra 20 per cent as a margin. Deep OTMs are strikes that are 30 per cent away from the underlying price at the time of the trade.

The National Stock Exchange has said the additional margin of 20 per cent on the notional value should be levied and collected from the clearing member in case an entity trades in equity derivative stock option contracts and create a new short position in the deep out of the money (OTM) strikes.

As an illustration, the NSE said, for the underlying price of Rs.100, 130-strike call option and 70-strike put option would attract a margin of 20 percent.

NSE circular further added that additional margin should be levied on the top 10 clients if they account for more than 30 per cent of the overall short positions on the trading day (to be computed in respect of call and put options separately).

The amount should be collected from the collaterals of the clearing member on the end of the day basis. The margin should continue to be levied on the clients till the contracts are squared off or till the expiry.

What is Deep Out of The Money (OTM) Contracts?

An option is considered deep out of the money (otm), if its strike price is considerably above for a call option or  below for a put option from the current price of the underlying asset. In layman terms this means, the strike price of the option must be more than a few strikes in the option chain away from the price of the underlying asset.

When the intrinsic value is the least, it is called Deep Out of the Money. Far the strike price from OTM (Out of the Money). Deeper out of the money the option is, the less likely it is to expire with any value.

How to identify ‘Out of the money’ OTM Call Options ?

If the intrinsic value is a zero(as IV can’t be -ve) the option strike is called ‘Out of the money’. In order to understand this we will choose Nifty50 strike price & calculate it’s intrinsic value. Let’s say

11350 (strike price)

Spot price of Nifty is 11250, keeping this in reference we would be calculating the intrinsic value for the strikes mentioned above:

Intrinsic Value (IV) = 11250 – 11350

= – 100

Negative intrinsic value, however we consider it as 0. As the intrinsic value is 0, the strike is called as “Out of the Money” (OTM).

11500 (strike price)

Intrinsic Value = 11250 – 11500

= – 250

Negative intrinsic value, however we consider it as 0. As the intrinsic value is 0, the strike is called as “Out of the Money” (OTM).

So the generalization that you can withdraw from above examples for a call options would be .

  1. All option strikes above than the ATM strike are considered OTM .
  2. All option strikes which are below the ATM strike are considered ITM (In the Money) .

Example of Deep Out Of The Money Option:

For example, if the current price of the underlying stock is Rs.100, a call option with a strike price of Rs. 130 would be considered deep out of the money. A put option with a strike of Rs.70 would be deep out of the money.

Conclusion:

People trade deep out of the money options as they are very low cost compared to other options with strike prices closer to the price of the underlying. However, the risk that the options will expire worthless is much more. On the other hand the potential size of the reward is also big if the option move in the money(ITM) before expiration. For this reason trader chooses Deep out of the money strikes while trading option in stock market. If you have any question or feedback please let us know in comment box below.

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