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What is margin penalty and how does it work?

As per SEBI regulations, margin shortfall penalty is levied on overnight positions held in the trading account without sufficient margin (SPAN & Exposure (initial margins), net buy premium, physical delivery margins and marked to market losses (if applicable)) as prescribed by the exchange. The margin penalty is levied on Equity Derivatives, Currency Derivatives, and Commodity derivatives segments. 

The penalty levied in case of shortfall in SPAN + exposure Margin for F&O positions:

Short collection for each client
Penalty percentage
(< Rs 1 lakh) And (< 10% of applicable margin)
0.5%
(= Rs 1 lakh) Or (= 10% of applicable margin)
1.0%

Note: The penalty is applied as a percentage of the shortfall amount and is posted in your ledger with the narration "Being CFX/F&O/MCX Margin Penalty Charges for the Trade Date".

Check out this page on the NSE and MCX for more information.

Please read this post for a detailed explanation of what margin penalties are and why they are charged.