NSCCL has developed a comprehensive risk containment mechanism for the Futures & Options segment. The most critical component of a risk containment mechanism for NSCCL is the online position monitoring and margining system. This brings in the need to price/value contracts under Derivatives being currently traded at the Exchange on an ongoing (daily) basis in order to calculate and collect different types of margin from the clearing/trading members and clients. The actual margining and position monitoring is done on-line, on an intra-day basis. NSCCL uses the SPAN(r) (Standard Portfolio Analysis of Risk) system for the purpose of margining, which is a portfolio based system. To identify the worst probable one-day loss on a portfolio, SPAN^� constructs a series of scenarios of changing underlying prices and volatilities for each derivative instrument in the portfolio, these "risk arrays" are central to the SPAN^�methodology, from this the worst probable outcome - the scanning loss - is selected.

NSCCL collects initial margin up-front for all the open positions of a CM based on the margins computed by NSCCL-SPAN^�. A CM is in turn required to collect the initial margin from the TMs and his respective clients. Similarly, a TM should collect upfront margins from his clients.

The objective of SPAN is to identify overall risk in a portfolio of futures and options contracts for each member. The system treats futures and options contracts uniformly, while at the same time recognizing the unique exposures associated with options portfolios like extremely deep out-of-the-money short positions, inter-month risk and inter-commodity risk.

Because SPAN is used to determine performance bond requirements (margin requirements), its overriding objective is to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day.

In standard pricing models, three factors most directly affect the value of an option at a given point in time:

1. Underlying market price

2. Volatility (variability) of underlying instrument

3. Time to expiration

As these factors change, so too will the value of futures and options maintained within a portfolio. SPAN constructs scenarios of probable changes in underlying prices and volatilities in order to identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin requirement at a level sufficient to cover this one-day loss.

SPAN(r) is a registered trademark of the Chicago Mercantile Exchange, used herein under License. At the heart of SPAN^� is the concept of the SPAN risk array. The risk array represents how a specific derivative instrument (for example, an option on a future) will gain or lose value, from the current point in time to a specific point in time in the near future, over a specific set of market conditions which may occur over this time duration, also called the look-ahead time. The look-ahead time is typically set to one trading day, because in SPAN we are trying to evaluate the maximum likely loss which may reasonably occur over one trading day.

The specific set of market conditions evaluated, are called the risk scenarios, are defined in terms of-

1. how much the price of the underlying instrument is expected to change over the look-ahead time, and

2. how much the volatility of that underlying price is expected to change over the look-ahead time.

The results of the calculation for each risk scenario, the amount by which the specific derivative instrument will gain or lose value over the look-ahead time under that risk scenario, is called the risk array value for that scenario. The set of risk array values for that contract (derivative instrument) under the full set of risk scenarios, constitutes the risk array.

By convention, risk array values are calculated for a single long position. "Long" here means long the instrument, not long the market: buying a put and buying a call both yield long positions for the purposes of SPAN. Also by convention, since SPAN is more interested in potential losses than potential gains, losses are represented as positive values, and gains as negative values. Risk array values are typically represented in the performance bond currency in which the specific contract is denominated.

Since its inception, SPAN has used a standardized definition of the risk scenarios, defined, as indicated above, in terms of the underlying price scan range, and the underlying price volatility scan range. These two values are often simply referred to as the price scan range and the volatility scan range. There are 16 risk scenarios in the standard definition. :

In the Risk Array, losses are represented as positive values, and gains as negative values. Risk array values are typically represented in the currency (Indian Rupees) in which the futures or options contract is denominated.

SPAN further uses a standardized definition of the risk scenarios, defined in terms of

1. the underlying 'price scan range' or probable price change over a one day period,

2. and the underlying price 'volatility scan range' or probable volatility change of the underlying over a one day period.

These two values are often simply referred to as the 'price scan range' and the 'volatility scan range'. There are sixteen risk scenarios in the standard definition. These scenarios are listed as under:

1. Underlying unchanged; volatility up

2. Underlying unchanged; volatility down

3. Underlying up by 1/3 of price scanning range; volatility up

4. Underlying up by 1/3 of price scanning range; volatility down

5. Underlying down by 1/3 of price scanning range; volatility up

6. Underlying down by 1/3 of price scanning range; volatility down

7. Underlying up by 2/3 of price scanning range; volatility up

8. Underlying up by 2/3 of price scanning range; volatility down

9. Underlying down by 2/3 of price scanning range; volatility up

10. Underlying down by 2/3 of price scanning range; volatility down

11. Underlying up by 3/3 of price scanning range; volatility up

12. Underlying up by 3/3 of price scanning range; volatility down

13. Underlying down by 3/3 of price scanning range; volatility up

14. Underlying down by 3/3 of price scanning range; volatility down

15. Underlying up extreme move, double the price scanning range (cover 35% of loss)

16. Underlying down extreme move, double the price scanning range (cover 35% of loss)

SPAN uses the risk arrays to scan probable underlying market price changes and probable volatility changes for all contracts in a portfolio, in order to determine value gains and losses at the portfolio level. This is the single most important calculation executed by the system.

As shown above in the sixteen standard risk scenarios, SPAN starts at the last underlying market settlement price and scans up and down three even intervals of price changes ('price scan range').

At each 'price scan point', the program also scans up and down a range of probable volatility from the underlying market's current volatility ('volatility scan range'). SPAN calculates the probable premium value at each price scan point for volatility up and volatility down scenario. It then compares this probable premium value to the theoretical premium value (based on last closing value of the underlying) to determine profit or loss.

Deep-out-of-the-money short options positions pose a special risk identification problem. As they move towards expiration, they may not be significantly exposed to "normal" price moves in the underlying. However, unusually large underlying price changes may cause these options to move into-the-money, thus creating large losses to the holders of short option positions. In order to account for this possibility, two of the standard risk scenarios in the Risk Array (sr. no. 15 and 16) reflect an "extreme" underlying price movement, currently defined as double the maximum price scan range for a given underlying. However, because price changes of these magnitudes are rare, the system only covers 35% of the resulting losses.

After SPAN has scanned the 16 different scenarios of underlying market price and volatility changes, it selects the largest loss from among these 16 observations. This "largest reasonable loss" is the 'Scanning Risk Charge' for the portfolio - in other words, for all futures and options contracts.

SPAN uses delta information to form spreads between futures and options contracts. Delta values measure the manner in which a future's or option's value will change in relation to changes in the value of the underlying instrument. Futures deltas are always 1.0; options deltas range from -1.0 to +1.0. Moreover, options deltas are dynamic: a change in value of the underlying instrument will affect not only the option's price, but also its delta.

Calendar Spread or Intra-commodity or Inter-month Risk Charge