What Is Hedge Break?

Hedging is a common strategy traders, and investors use to reduce or offset their potential losses from adverse price movements in financial assets. This can be achieved through various combinations of Instruments like Future, Options, and Spot. 

Now let me ask you a question – Have you ever encountered a scenario where you exited a position and received a margin shortfall intimation? Have you ever wondered why exiting any trade can lead to a margin shortfall or increase the margin requirement? This is where we must introduce you to the concept of hedge break and its implications on margin requirements. It is a situation where you exit one of the positions from the hedging transaction and break the hedge. 

With the regulator implementing the Peak Margin Requirement, squaring off your low-margin hedge position may attract a penalty. How? If you square off the low-margin leg before squaring off the higher-margin leg, your peak margin requirement will shoot up, and if you have insufficient balance, it may lead to a penalty. We have introduced a new feature that will prevent you from entering hedge break trades (explained below) and save you from penalties.

What is a hedge break?

A hedge break happens when you try to break the hedge by squaring off one of the positions that had provided the hedge benefit on another contract. Let’s understand the margin requirement in the case of hedging and hedge break with the example below.

Please consider that you have ₹21,500 in your account as of 07-Sep-23. 

From the above table, it is clear that a hedging benefit of ₹82,700 was provided on 1 Buy Lot of NIFTY 50 19650 CE position because of 1 Sell Lot of NIFTY 50 19650 CE. When you square off your buy position, the hedge benefit will be revoked, resulting in a hedge break. This increases the margin requirement to ₹1,02,300 from ₹19,600 to hold the position. Thus, you need ₹82,700 in your account or may attract an intimation for margin shortfall.

What happens in the case of a hedge break at Angel One?

If the user breaks the hedge without maintaining the required balance, there will be a margin shortfall of a differential amount. Continuing with the above example, let’s say you have ₹21,500 in your account and need ₹21,400 (19,600 margin + 1,800 premium) to create a Bull Call Spread of 1 Buy Lot of NIFTY 50 19600 CE and 1 Sell Lot of NIFTY 50 19650 CE. 

Once you have entered the transaction, you will be left with only ₹100 (₹21,500-₹21,400) in your account. Now, if you square off the buy position, you will need additional funds of ₹82,700 to maintain ₹1,02,300 in your account since you have only paid ₹19,600 due to hedging. As mentioned earlier, you only have ₹100 in your account, which means you have a negative account balance of ₹82,600. 

What’s the new implementation in hedge break at Angel One?

The newest feature restricts hedge break transactions from proceeding if you don’t have sufficient margin. So, what changes now is that if you try to square off your lower-margin position before the higher-margin leg without having sufficient margin in your account, your order will be rejected to avoid a negative balance. This way, we will save you from the margin shortfall penalty. However, your order will go through if you have sufficient balance in your account.

How to exit in case of a hedge break?

To exit from the adverse leg of the hedge, either maintain a sufficient margin before entering the hedge break transaction or exit the entire hedge position together by exiting the higher-margin hedge position first. 

Scenarios of hedge break

Below are a few more hedge break scenarios and examples for better understanding.

For the below examples, please note that we have taken NIFTY with an expiry of 28-Sep-23. 

1. Short Future Hedge 

In the above case, if you try to exit from the long call position, you will require a margin of ₹89,857. However, the system won’t allow a hedge break if you fail to maintain sufficient margin. 

2. Long Future Hedge

In the above case, if you try to exit from the long put position, you will require a margin of ₹77,445. However, the system won’t allow a hedge break if you fail to maintain sufficient margin. 

 

3. Bull Spread

• Situation 1 

In the above case, if you try to exit from the short call position, you will require a margin of ₹90,288. 

However, the system won’t allow a hedge break if you fail to maintain sufficient margin. 

• Situation 2

In the above case, if you try to exit from the short put position, you will require a margin of ₹77,582. However, the system won’t allow a hedge break if you fail to maintain sufficient margin. 

4. Bear Spread

• Situation 1

In the above case, if you try to exit from the long put position, you will require a margin of ₹74,047. However, the system won’t allow a hedge break if you fail to maintain sufficient margin. 

• Situation 2

 

In the above case, if you try to exit from the long call position, you will require a margin of ₹84,826. However, the system won’t allow a hedge break if you fail to maintain sufficient margin. 

Disclaimer Please note that we have considered NIFTY with an expiry of 28-Sep-23 for all the above examples. All the calculations are done on the closing rates of 08-Sep-23 and the strike price of ₹19,700. The margin/data mentioned above should not be considered final; kindly check the app or risk policy documents for computing the latest margin.

How to know if my order is rejected due to a hedge break?

On the Angel One app, when you place an order that can lead to a hedge break without sufficient balance, you will receive a pop-up rejection message titled ‘Order Rejected’ (below is the screenshot for your reference).

Conclusion

Hedging is essential for traders and investors as it helps them minimize risk exposure. Consequently, knowing about hedge break is equally important to avoid the margin shortfall. Hedge break is a concept in which you exit one position that has hedged the other position, which may lead to margin shortfall if you don’t have sufficient funds in your account. We have introduced a new feature that will restrict you from entering hedge break trades and protect you from margin shortfall.