NISM Certifications · NISM-Series-VIII: Equity Derivatives

Introduction to Clearing and Settlement System: formula sheet

Full chapter guide

Key formulas

Process sequence: Trade execution → Clearing → Settlement; Clearing always comes before settlement. Settlement is the final discharge of obligations.
Clearing vs settlement: Clearing = determine and guarantee obligations; Settlement = discharge obligations; Clearing is about calculation, margins and guarantee. Settlement is about actual movement of funds or securities.
Chain of dealing: Client → Trading member → Clearing member → Clearing corporation; The client has no direct dealing with the clearing corporation.
Role split: Exchange = trading platform; Clearing corporation = counterparty, risk management and settlement; Clearing member = settles obligations; The clearing corporation, not the exchange, guarantees the trade after novation.
Clearing corporation role: Novation + guarantee + margin collection + obligation computation + risk management; It becomes the counterparty to every trade. Do not say it trades or gives investment advice.
Self-clearing member: Trades + clears own trades + own clients' trades only; It is a trading member with clearing rights, so it trades. It does not clear for other trading members.
Trading-cum-clearing member (TM-CM): Trades + clears own, clients' and attached trading members' trades; A trading member without clearing rights must attach to a clearing member.
Professional clearing member (PCM): Clears only; does not trade; Clears for trading members and, where applicable, institutional clients.
Clearing bank vs custodian: Clearing bank = funds settlement; custodian = confirmation and settlement of institutional trades; A common pairing trap in MCQs.
Effect of novation: Buyer ⇄ CCP ⇄ Seller (replaces Buyer ⇄ Seller); The CCP is seller to every buyer and buyer to every seller. One trade becomes two contracts.
CCP net position: Total long positions = Total short positions, so CCP net = 0; The clearing corporation takes no market view. It carries credit risk, not price risk, on matched positions.
Guarantee rule: Settlement guarantee = CCP obligation to perform, backed by margins + guarantee fund; The guarantee is to the clearing member. It is not a guarantee of profit or of price.
Order of default resources (concept): Defaulter's margin and deposits first, then the guarantee fund and other resources; The defaulter's own resources are used before the common fund. Check the workbook wording for the exact waterfall.
Total margin on a position: Initial margin = SPAN margin + Exposure margin; Initial margin is collected upfront. MTM is separate and is settled daily.
SPAN margin: SPAN margin = Scanning risk + Calendar spread charge − Inter-commodity/spread credit, subject to short option minimum; Calculated at portfolio level. Scanning risk is the worst loss across the 16 scenarios.
Exposure margin (index futures, simple form): Exposure margin = Exposure % × Contract value; Contract value = price × lot size × number of lots. Use the percentage given in the question.
Daily MTM: MTM (long) = (Today's settlement price − Previous settlement price) × Quantity; For a short position, reverse the sign. On the day of trade, use the trade price instead of the previous settlement price.
Long option margin: Long option: premium paid, no further margin; Short option positions attract SPAN and exposure margin.
Daily MTM on a long futures position: MTM = (Today's settlement price − Previous settlement price) × Lot size × Number of lots; Positive means profit received. For the first day, use the trade price instead of the previous settlement price. For a short position, reverse the sign.
Final settlement of futures: Final MTM = (Final settlement price − Last daily settlement price) × Quantity; Final settlement price is the closing price of the underlying on expiry day. Total profit over the life equals (Final settlement price − Entry price) × Quantity.
Cash settlement of an index option at expiry: Call payout = max(Final settlement price − Strike, 0) × Quantity; Put payout = max(Strike − Final settlement price, 0) × Quantity; The buyer receives this amount and the seller pays it. Premium is settled separately.
Physical settlement of an exercised stock option: Call buyer pays Strike × Quantity and receives shares; Put buyer delivers shares and receives Strike × Quantity; Applies to in-the-money stock options at expiry. The price is the strike, not the market price.
Settlement mode rule: Index derivatives: cash settled. Stock derivatives: physically settled.; Daily MTM and premium are always settled in cash, even for stock derivatives.

Quick revision

Clearing determines obligations; settlement discharges them by payment or delivery.
The clearing corporation guarantees performance of trades it clears.
Novation replaces the original buyer-seller contract with two contracts with the clearing corporation.
After novation, the clearing corporation acts as buyer to every seller and seller to every buyer.
Clearing members clear and settle trades with the clearing corporation; trading members who are not clearing members need a clearing member.
Margins protect the clearing system against member default.
Mark-to-market brings open positions to the day's settlement price and moves the gains and losses.
Initial margin is collected upfront on open positions to cover potential loss.
Option buyers pay the premium; option sellers face margin requirements.
Check in your workbook whether each contract settles in cash or by delivery.
Wrong answers cost 25% of the question's marks, so skip a question when you are truly unsure.

Common mistakes

Treating clearing and settlement as the same thing. Fix: Link clearing with calculating obligations and guaranteeing them, and settlement with the actual discharge in cash or securities.
Saying the exchange guarantees the trade. Fix: The clearing corporation guarantees performance by becoming the counterparty to both sides.
Saying a professional clearing member can trade. Fix: A PCM only clears and settles. It has no trading rights.
Saying a self-clearing member clears for other trading members. Fix: Self-clearing means own trades and own clients' trades only.
Saying novation means the two original parties still have a contract with each other. Fix: Remember the original contract is extinguished and replaced by two new ones with the CCP.
Believing the CCP guarantees that you make a profit or protects you from price loss. Fix: The guarantee covers settlement performance, not market outcomes.
Treating MTM margin as part of initial margin. Fix: Initial margin is collected upfront for potential loss. MTM settles actual daily gains and losses.
Thinking SPAN is calculated contract by contract. Fix: SPAN is portfolio based and recognises offsetting positions, so a spread needs less margin than two outright positions.
Saying stock futures are cash settled at expiry because daily MTM is in cash. Fix: Daily MTM is cash for all futures. Only the final settlement differs: cash for index, physical for stock.
Using the previous day's closing price instead of the trade price for the first day's MTM. Fix: On the day of the trade, MTM is settlement price minus the price at which you traded.

Exam tips

Expect definition questions that ask you to separate clearing from settlement. Learn one clear line for each.
Watch for options that give the exchange the clearing corporation's guarantee role.
Know that only clearing members deal with the clearing corporation. Trading members need one to clear.
In NISM Series VIII a wrong answer costs 25% of the marks of the question, so eliminate options by stage and entity before guessing.
Learn the three clearing member types as a table in your head: trades, clears, for whom.
Expect one-line definitional MCQs. Match the key verb: guarantees, clears, funds, confirms.
Absolute words like only and never are traps. Check them against the definitions.
This topic links to novation and margining, so revise those together.