Understanding MTM in Options Trading

CA Manish Singh: 
Hi everyone. In this video, we will understand what MTM is in options trading. 

The moment you take any trade, it immediately starts moving either towards profit or towards loss. That is the basic idea. But what exactly is MTM? 

MTM stands for Mark to Market. It simply means that if you decide to square off your trade right now, what would be your profit or loss at this moment. Eventually, your real profit or loss is only known when you actually close the trade. But till the time your trade is open, MTM comes into the picture. 

When your trade is open, MTM is the running profit or loss that you see on the screen. 

What is MTM for an Option Seller? 

CA Manish Singh: 
Let us understand this with an example. 

Assume you are an option seller. You have sold an option and for that you have blocked around ₹2 lakh as margin. 

Let us say you have sold a Put option at ₹10. You know that unless the market falls by around 120 points, you are not really in serious trouble. You are not expecting such a big fall, so you are comfortable with the position. 

But for a brief period, suppose on the same day, the market falls by 40 points. 

What will you see? 
You will see an MTM loss on your screen. 

Why? Because of Delta. As we discussed earlier, if the Delta is around 0.5 at the money, then for a 40 point movement, the option premium can move around 20 points. So your option, which you sold at ₹10, may move up by around 20 points on Delta impact. 

Now, Theta decay will also start working. Suppose Theta decay reduces some of that move by about 7–8 points, then net impact might be around 13–14 points of loss in the premium. 

You will see this 13–14 point loss multiplied by the lot size, for example 75, as an MTM loss on the screen. That is not your booked loss. You have not squared off the position. It is only a running loss. 

This running profit or loss, which you have not yet booked, is called MTM value. 
If you are in loss, it is MTM loss. 
If you are in profit, it is MTM profit. 

The moment you square off the trade, MTM converts into actual profit or loss. 

MTM is created in the system so that you always see the real-time impact of market movement on your open positions. 

Why MTM is Important in Option Selling 

CA Manish Singh: 
Now, as you know, option selling theoretically has unlimited loss potential. The market can move sharply in any direction. 

Let me show you this with an example. 

Assume you have sold a 25,450 Call option. 

Tomorrow, suddenly there is very good news in the market. The market moves up to around 25,790. 

In that scenario, you may end up seeing a loss of around ₹18,000 on your position. 

What if the market moves even higher, say towards 26,000 or beyond? 
Your MTM loss may go to ₹1,68,000 also. 

You might say, “Sir, I will cut my position before it goes that far.” 

But what if there is a sudden big gap up in the market, or a big event? 

In 2009, when Dr Manmohan Singh was re-elected as the Prime Minister of the country, he was already known as a respected economist and people believed he had steered India through the earlier economic crisis. Because of that confidence, on that day the market opened at an upper circuit of 10%, then again hit another upper circuit. 

So, on that very day itself, the market went up by around 18%. 

In our example, I have still only considered a 10% move. Imagine sitting with an option short position on such a day. 

These kinds of events are rare, but they have happened in the history of the market. Because such sharp moves are possible, margin systems and MTM calculations are designed to factor in this kind of extreme risk. 

Why the Margin is Kept So High 

CA Manish Singh: 
We discussed that to sell one lot of such an option, the margin requirement is around ₹2 lakh. 

This margin is calculated assuming a possible extreme move of around 10% in the index. If the market moves 10% in your adverse direction, your maximum loss in that scenario might be somewhere near ₹1,81,000. 

So the system says: 
“Is ₹2 lakh margin sufficient to cover such a loss?” 
Yes, in that extreme case, it is considered sufficient. 

In the history of the Indian stock market, a 10% upper circuit has happened only twice, and both those instances occurred on the same day. Which means there has been only one day in the entire history of Indian markets where such a double upper circuit took place. 

So it is a once-in-a-lifetime type of event. 
The margin framework is designed in such a way that even if such a rare event happens, the margin is able to cover the potential loss. 

MTM Fluctuations with Time and Price 

CA Manish Singh: 
Now let us see how MTM keeps changing with price movements and time decay. 

Assume the market is at 25,460 when you sell the option. Later, it moves to 25,500. 

At the end of Friday, your projected loss on that option might show around ₹2,600. This is MTM loss at that point. 

However, you also have the advantage of Theta, or time decay. 

Suppose you decide to hold the position till Monday. 
By Monday, because of time decay, that projected loss might reduce and your position may even start showing a profit. 

So, the same ₹2,600 MTM loss that you saw on Friday was still an MTM number, not a booked loss. 

Assume on Tuesday, your MTM now shows a profit of around ₹2,400. If at that moment you decide to book the trade, that profit becomes actual. 

But what if on Tuesday, instead of falling, the market is now at 25,600? 
Your MTM might now show a loss of around ₹2,700. 

Let us move one more day ahead to Wednesday. Suppose again the market is still around 25,600. Your MTM loss may now have reduced to around ₹1,200, thanks to additional time decay. 

On Thursday morning, if the market finally falls back towards 25,500, the MTM may flip back into profit. At the time of expiry, when it finally gets squared off, that MTM will convert into actual profit. 

So MTM will keep fluctuating up and down every day, and even within the day, until you close the trade. 

How MTM is Settled with the Broker 

CA Manish Singh: 
Now let us talk about what actually happens with MTM at the broker level. 

In case of MTM loss, you have to pay this loss amount to your broker for that trading day. 

Why is that? 
Because to keep your position open, your broker has to fund your losses in the clearing system. The broker has to pay these MTM losses to the exchange. Therefore, if MTM loss increases too much, you must deposit additional money with your broker so that he can maintain sufficient margin with the exchange and your position does not get squared off. 

So, in option selling, whenever MTM loss goes up, you need to fund that loss to keep the trade alive. 

What about MTM profit? 

Until you actually square off the trade, your MTM profit is only on paper. You will not get any final benefit from it till it is booked. Only when you close the position does it become realised profit. 

So, to summarise: 
• MTM loss must be funded promptly 
• MTM profit becomes real only when booked 

This is the basic concept of MTM in options trading. 

Connecting MTM with Technical Analysis 

CA Manish Singh: 
In the next chapter, we will learn how to use technical analysis in options so that whatever MTM we are seeing, we can try to convert more of it into actual profit instead of just watching it fluctuate. 

See you in the next chapter. 

Disclaimer: Investments in securities markets are subject to market risks. Read all related documents carefully before investing.