The word comes from the French word, lever, to lift up.
If you’ve used a lever with a fulcrum, to move a heavy and large object, you know the force is amazingly powerful. Investors use leverage to multiply their buying power in the market. As initial margin suggests, in order to buy 1 futures contract, the trader needs to pay only a small percentage of the total value of the contract, one could think of it as, larger exposure to an underlying asset with very small initial margin. This is leverage, gains and losses in such scenarios is manifold.
An illustration: If the initial margin required is 20% for a futures contract. This implies that if the underlying equity returns 10%; due to leverage (as one doesn’t pay the entire amount) in futures contract; the percentage returns would be magnified to Equity returns*100/initial margin, i.e., 50% in this example.
In order to avoid excessive concentrated speculation, cartelisation to such an extent that it has a large bearing on the price of an F&O stock, hence barriers or limitations need to be placed in terms of positions held, namely, market wide position limits.
Market Wide Position Limits (for Derivative Contracts on Underlying Stocks)
Daily at the end of day, NSE disseminates the aggregate open interest across all Indian Exchanges in the futures and options on individual scrips along with the market wide position limit for that scrip and tests whether the aggregate open interest for any scrip exceeds 95% of the market wide position limit for that scrip. If yes, the Exchange takes note of open positions of all positions as at the end of that day in that scrip, and from next day onwards the aforementioned scrip enters the Ban list. Traders should trade only to decrease their positions through offsetting positions till the normal trading in the scrip is resumed.
The normal trading in the scrip is resumed only after the aggregate open interest across Exchanges comes down to 80% or below of the market wide position limit.
Position limits of Trading members / FPIs (Category I & II) / Mutual Funds
The position limits of Trading members / FPIs (Category I & II) / Mutual Funds in equity index option and index futures is mentioned as under: