A desk with a Rs 5 crore one-day VaR limit sits at Rs 4.6 crore, and a client trade would take it to Rs 5.6 crore. It can reject the trade, hedge with index futures to cut VaR by Rs 0.8 crore for Rs 3 lakh, or ask for a temporary limit. What do you do?

Do the trade and hedge: VaR lands at Rs 4.8 crore, inside the Rs 5.0 crore limit, for Rs 3 lakh against about Rs 20 lakh of margin. Rejecting keeps the limit but loses the client and the revenue. A temporary limit costs nothing in cash but puts a breach on record for a trade the desk could have hedged. Before relying on the hedge, check that the Rs 0.8 crore reduction survives a stress, because index futures hedge the market factor and nothing else.

Think of a weight limit on a bridge. It is not a prediction that the bridge collapses at one kilo over; it is a line the owner drew so that nobody has to argue about each lorry. A VaR limitThe largest one-day loss, at a stated confidence, that the risk committee has agreed the desk may be exposed to. A cap on size, not a forecast. works the same way: it converts the committee's appetite for loss into a number the desk can test every trade against. One-day 99% VaR of Rs 4.6 crore says that on a normal day the desk should lose more than that about one day in a hundred. The limit of Rs 5.0 crore is the committee saying it does not want that number larger, whatever the opportunity.

Lay them side by side with the same three columns: where VaR ends, what it costs, and what it leaves behind. Rejecting leaves VaR at Rs 4.6 crore and costs the Rs 20 lakh of margin plus a client who will remember being turned away; hedging leaves VaR at Rs 4.8 crore, costs Rs 3 lakh, and keeps the client and Rs 17 lakh of margin; the temporary limit leaves VaR at Rs 5.6 crore, costs nothing today, and leaves a breach on the record. The hedge wins on every column but cash cost, and Rs 3 lakh is 15% of the margin. The desk would normally hedge part of the trade's delta anyway, so some of that cost would have been spent regardless.

Candidates like it because nothing is spent. A limit that is raised whenever a good client calls is not a limit, and the committee that raised it for this trade will be asked to raise it for the next, so the real cost is the loss of the line the limit exists to draw. There are legitimate uses: a hedge that cannot be executed until tomorrow, or a position that will roll off in two days, where the committee grants a dated and documented exception. A trade that can be hedged for Rs 3 lakh is not one of them. If the desk finds it is at Rs 4.6 crore against Rs 5.0 crore every week, the conversation to have is about the size of the limit, not about one trade.

Two things. First, what the hedge covers. Index futures remove the market-direction exposure the put spreads add, which is why VaR falls Rs 0.8 crore, but they do nothing for the volatility exposure or the gap risk of a short put spread, and the VaR model may be giving the futures more credit than a stress would. Ask the risk team for the stressed loss on the hedged position, a 5% gap with volatility up, and confirm the desk still likes the number. Second, the headroom. After the hedge the desk has Rs 0.2 crore of room, so the next client trade of this size needs the same treatment, and a volatile day can lift VaR on an unchanged book. Close by saying what you would actually do: price the hedge into the client's spread where you can, execute the futures with the trade, and tell the risk team the day's plan before the system flags it.