The Settlement Price: The Number a Margin Call Uses

A settlement price is the price a clearing corporation determines for a contract at the close of a day, and every open position in that contract is revalued against it. A settlement price is not the last price somebody traded at, and it is nobody's opinion of value. The day's collateral call is struck on that number, and that is why the method behind it is settled before the day begins rather than after it.

A promise is only as good as what backs it, and what backs it has to be measured against something every single day. The measure cannot be whatever price was last seen on a screen. Two people watching two screens would owe each other different amounts by the end of the evening. The arrangement needs one number, arrived at the same way every day, that everybody is bound by before anybody knows whether it helps them. The settlement price is that number, and where it comes from is the reason it can do the job.

Everything here runs on one invented set of figures, so it is worth fixing them before anything else. There is a reference asset, invented for this guide and standing in for whatever a contract might reference. Its spot price is Rs 2,000.00/-, a PRICE, and that same figure is the exposureThe value of the referenced thing that a position stands on. The exposure is the base a margin percentage is struck on, and it is not an amount that changes hands. carried by one unit. The reference asset pays nothing at all while it is held. A payout during the holding period would change every carried figure below, so an asset that pays nothing keeps the arithmetic clean.

Financing costs 6.50 per cent a year. Carry one unit for a year and the cost is Rs 2,000.00/- multiplied by 1.065, giving Rs 2,130.00/-. Rs 2,130.00/- is the agreed price, and it is a PRICE. The agreed price is arithmetic performed on a rate, and it is not a forecast that anything will rise by 6.50 per cent over the year. Anybody who reads it as a view about the future has read a cost as an opinion.

Against that position sits collateral. The initial marginCollateral put up before a position is carried. Initial margin is not a payment for the position and it is not a deposit toward the price. It is what the arrangement holds while the promise is open. used throughout this guide is 8.0 per cent of the Rs 2,000.00/- exposure, giving Rs 160.00/- on one unit, and that 8.0 per cent, invented for teaching, is not a requirement anybody has set. What is actually asked for is set by clearing corporations under the framework of the Securities and Exchange Board of India (SEBI) at sebi.gov.in, it differs by contract and by day, and it moves, so it is confirmed at source rather than taken from a printed figure. The invented figure exists to expose a ratio, and that ratio survives whatever the real percentage turns out to be.

What is a settlement price, and what is it not?

A settlement priceThe price determined at the close of a day that every open position in a contract is revalued against. Determined by a stated method, not picked up off the last trade. is determined at the close of a day by the clearing corporationThe party that stands between the two sides of every position, so that neither side has to look at the other., by a method that was settled in advance. Hold on to the verb. The price is determined. Somebody applies a stated rule and a number comes out the other end.

Most readers arrive carrying at least one of three mistakes. A settlement price is not necessarily the last price traded, it is not a quote anybody could have dealt at, and it is not a valuation of the reference asset for any other purpose. Each of those is a different mistake and each costs a different thing. The first turns an accident into an obligation. The second invites an argument that a better number could have been had. The third leaks a figure built for one narrow job into decisions it was never built for.

An everyday arrangement does the same job. A milk co-operative collects from two hundred households in a morning. The co-operative fixes one price for the day's collection and pays every household on that number, rather than on whatever the last buyer through the gate happened to offer at half past eleven. Nobody thinks the fixed price is a lie about what milk is worth. Everybody understands it as the number the day's accounts run on, arrived at by a rule that was agreed before the churns arrived.

Set that beside a last traded priceThe price of the most recent trade in a contract. A last traded price records what two parties did with each other, and it is not the number a revaluation uses. and the two separate cleanly. They differ on three things at once: who produced them, what they are for, and whether anybody could have dealt at them.

Why is a settlement price determined rather than simply observed?

A price that is simply observed is whatever the last trade happened to be. The last trade may have been one small trade, late in the day, between two parties with a reason of their own for doing it at that moment. The trade is a real event and it is honestly recorded, and it is still a thin thing to hang an evening on. If the last trade decided the number, the collateral called from every open position in the contract that evening would be struck on an accident.

So the price is arrived at by a stated method instead. The exchange sets the method and what it draws on, under the framework of SEBI at sebi.gov.in. The method differs by contract, and it moves, so it is read at source on the day it is needed. A method written out somewhere else would not be merely out of date on the day it changed. A stale method would be wrong, and wrong in the confident voice of something printed.

A settlement price cannot be worked out from the method alone. The method needs the trade record it draws on, and that record sits with the exchange. Every settlement price below, invented for teaching, is derived instead from a stated percentage move on the Rs 2,000.00/- exposure. The arithmetic can then be followed without a single trade record.

What does the settlement price actually do once it exists?

The settlement price matters entirely because of what happens next. Once it exists, every open position in the contract is revalued against it and the difference is collected or paid. The act of revaluing has a name: the position is markedRevalued against the settlement price. Marking is the arithmetic; the call that follows is the money.. The arithmetic is worked through below on the invented figures rather than taken on trust.

The agreed price is Rs 2,130.00/-, a PRICE. The settlement price determined for the day is Rs 2,050.00/-, also a PRICE. The distance between them is Rs 80.00/-, and that Rs 80.00/- is 4.0 per cent of the Rs 2,000.00/- exposure. The figure comes from that percentage rather than being asserted. Rs 2,130.00/- less Rs 80.00/- is Rs 2,050.00/-. The Rs 80.00/- is then a PAYMENT, and it leaves the long position's balance that evening. Nothing was bought at Rs 80.00/-. The Rs 80.00/- is the amount that moved because two prices differ.

Now the second limb, and the two have to be read together because either one alone misleads. The balance posted was Rs 160.00/-, being an invented 8.0 per cent of the Rs 2,000.00/- exposure. So the Rs 80.00/- that left is 50.0 per cent of what was put up. And Rs 2,000.00/- of exposure standing on Rs 160.00/- of collateral is 12.50 times. A four per cent move in the referenced thing takes half of what was put down, and that ratio, not the exposure and not the size of the contract, is what makes these positions different to hold.

Read the two limbs in the other direction and the same fact appears. One divided by 12.50 is 8.0 per cent, so a move of 8.0 per cent of the exposure would take the whole of what was put up. The 8.0 per cent repeats the invented margin percentage for one reason only: that percentage set the Rs 160.00/- in the first place. The repetition is the same number wearing a second hat, not a coincidence worth reading anything into.

Readers most often stop checking here, so say the label out loud one more time before moving on. The 8.0 per cent here is an invented teaching figure. What a clearing corporation actually calls for is set under the framework of SEBI at sebi.gov.in and moves. Change the percentage and the Rs 160.00/- changes, the 50.0 per cent changes and the 12.50 times changes. The shape does not change: a small percentage of a large exposure is a large percentage of the collateral, and that holds at any margin percentage anybody sets.

Why does every position in one contract have to use the same number?

Because what is collected from one side is credited to the other. A position holderThe party carrying a position. on the long side pays Rs 80.00/- and a position holder on the short side receives Rs 80.00/-, and those two figures have to be struck on the same price or the evening does not add up. Two numbers would mean the collections and the payments differ, and the difference would have to come from somewhere or go somewhere, and there is nowhere for it to go.

Take six invented positions in the same contract, three long and three short. Each long position pays Rs 80.00/-, so Rs 240.00/- is collected. Each short position receives Rs 80.00/-, so Rs 240.00/- is credited. The settlement price is not a service rendered to any position holder. It closes the day's arithmetic. A reader who takes that on board stops reading the number as a valuation and starts reading it as a pivot: it is the point both sides turn on, and its job is symmetry rather than accuracy about anything else.

The same requirement shows up in a chit arrangement run among twelve neighbours. Whatever the rule is for deciding what each person owes in a month, it cannot give two members different answers about the same month. Two answers leave the pot unbalanced and somebody short. Fairness does not force one number. Arithmetic does.

Why is the method settled before the day starts rather than after it?

A method chosen after the close is a method somebody can argue with. The argument then arrives on the evening the money has to be called and found, and that evening has no time for one. An arrangement that has to work under pressure fixes its rules while nobody yet knows who they help. The rule carries more of how cleared markets are built than any list of steps would.

The order of the evening does something a reader usually misses, so look at it closely. The day closes. The settlement price is determined. Every open position is revalued against it. The call goes out. The call goes out while the position is still open, and that timing is the whole reason the arrangement works at all. Nothing has gone wrong at that moment. Nobody has failed. Collateral is being asked for while the money can still be found, rather than after a loss has already landed somewhere it cannot be recovered from.

The method behind step two is set by the exchange under the framework of SEBI at sebi.gov.in and is read there. The method exists and is fixed in advance, and fixing it in advance is the point rather than an administrative detail.

How is the settlement price on the final day a different animal?

On every ordinary day the settlement price is an internal reference. An ordinary settlement price decides what moves between the two sides today, and tomorrow another one decides tomorrow. Get one slightly odd and the next one corrects the position. The marks accumulate against the same agreed price, so an error in one day's number washes through into the next day's mark.

The final settlement priceThe price that closes the obligation itself on the last day of a contract, rather than deciding what moves on one more day of its life. does a different job. The final settlement price closes the obligation itself. There is no tomorrow to correct it, and nothing follows it. The two carry almost the same words and do work of different kinds, and confusing them is how a reader ends up thinking that the last day is simply one more ordinary day with a bigger number on it.

How the final settlement price is arrived at, and from what, is set under the framework of SEBI at sebi.gov.in and differs by contract. The rules for that one price are written with more care than the rules for any of the others, for one reason: it is the only one never revisited.

Is this figure a price, a payment or a net?

Every figure in a cleared position is one of three things, and saying which belongs inside the sentence rather than in a note under it. A PRICE is what is agreed, quoted or determined: Rs 2,000.00/- spot, Rs 2,130.00/- agreed, Rs 2,050.00/- determined for the day. A PAYMENT is what actually leaves or reaches an account: Rs 80.00/- called on the first day. A NET is what is left when obligations in both directions have been set against each other. Netting is a separate machine and is covered separately. A settlement price and a payment sit in one sentence and only one of them moves, so mixing the three is the commonest error in this arrangement.

Watch the labels hold across three days, each settlement price derived the same way and none of them transcribed. Day one is a 4.0 per cent move of the Rs 2,000.00/- exposure away from the agreed price, so Rs 2,130.00/- less Rs 80.00/- is Rs 2,050.00/-. Day two is a 2.0 per cent move back, so Rs 2,050.00/- plus Rs 40.00/- is Rs 2,090.00/-. Day three is a 1.0 per cent move away, so Rs 2,090.00/- less Rs 20.00/- is Rs 2,070.00/-.

The three marks are Rs 80.00/- out, Rs 40.00/- in and Rs 20.00/- out. Added together they are Rs 60.00/- out. And Rs 2,070.00/- less Rs 2,130.00/- is Rs 60.00/- exactly. The payments made along the path add to the distance between the agreed price and the last settlement price. Settling every day is for exactly that: the whole difference has already moved by the time the final day arrives. Notice also what did not move. The exposure was Rs 2,000.00/- on day one and it was Rs 2,000.00/- on day three. The collateral behind it changed.

What can be concluded from a settlement price, and what cannot?

Two things follow, and they are both narrow. The first is that positions in that contract were revalued at Rs 2,050.00/- for that day. The second is that a long position of one unit against an agreed price of Rs 2,130.00/- was called for a payment of Rs 80.00/-. The list ends there.

The settlement price does not say what the reference asset is worth. Because the price was determined rather than offered, nobody was necessarily able to deal at it. And nothing at all follows about where the price goes next. A settlement price carries no view: it is arithmetic performed on a stated method, and it is a cost measured rather than an opinion offered. A reader who treats it as a signal has taken a bookkeeping instrument and asked it a question it has no machinery for answering.

What is left unanswered about holding a position that can be called?

The arithmetic raises a question that deserves a straight answer rather than a hedge. The question is whether anybody should be holding something that can take Rs 80.00/- out of Rs 160.00/- on an ordinary Tuesday when nothing dramatic happened.

No arithmetic answers that question. The answer turns on facts about the holder rather than facts about the contract. Anybody answering it would first have to know: what the position exists to do, and whether it is offsetting something already held or standing on its own; what is already held against it; what has been put up; what else could be put up at short notice and how quickly it could get there; and what reaches the account on the worst day rather than on the average one.

No track record and no measured probability stands behind the arithmetic above, and neither would settle the question if it did. Understanding exactly how a call works is not a reason to be on the receiving end of one.

The reference asset, every price, every payment and every margin figure shown here are invented.
Educational material. Not advice on any investment, tax, budget or market position.