In the US markets, for example, a ‘hedge’ rate of initial margin is
quoted which can be applied to positions that are a hedge. This is a
position where the opposite side reduces the risk of one side of the
position.
Movements in the market would have a negative impact on one side
but a positive impact on the other side. This would be a significantly
lower initial margin rate than a ‘spec’ rate, which carries the full risk
of the position, as there is no balancing side to offset any of the risks.
London SPAN calculates an inter-month spread charge to compen-
sate for the basis risk incurred because futures prices do not correlate
exactly across contract months. This is calculated for futures and
using the delta value for options to convert them to equivalent futures.
Where a spread exists but does not have equal and opposite sides the
spread margin is only charged on the number of contracts that are
equal. The remaining contracts are charged margin at the full rate.
The inter-month spread charge calculation is:
Number of spreads inter-month spread charge rate
Additionally certain different contracts can be offset across portfolios,
where the clearing house can justify it on risk grounds.
Delta spreads are used in the calculation:
Weighted futures price risk spread credit rate number of
spreads delta spread ratio
In order to calculate the total initial margin requirement, the follow-
ing rule is applied:
Scanning risk Inter-month spread charge Spot month charge
Inter-commodity charge
Note: ‘Delta’ is also a term used in options where it is the rate of
change of price of the option in response to a change in the price of
the underlying asset (see Appendix 9: SPAN).
Variation margin
We know that for most types of futures contracts, the clearing organ-
isation pays and collects the profit or loss that is accruing on the
open futures positions as the price moves up or down each day. This
movement generates pay-and-receive situations for the members
with the open positions. The clearing organisation will call in and pay
out this net amount to each clearing member daily. This amount is
known as VM.
Margin and collateral 129
For other types of futures contracts, usually known as forwards,
the VM is calculated each day but any profits accrued are not paid
out until the settlement date of the contract.
This applies even if the position is closed out in the exchange early
on in its life. The profit will stay with the clearing house until the set-
tlement (delivery) date.
Any profit that is accrued can be used to offset initial margin
requirements but it does not attract interest, as it is unrealised.
All losses that occur must be settled on a daily basis. This is true
of contracts traded on the LME and the Swedish markets.
An example of the calculation of VM over a period of time follows:
The client buys 1 Sep. Long Gilt Future at 109.13 on June 1st.
The client sells the position at 109.42 on June 8th.
The contract size is £100 000 nominal value with a minimum price
fluctuation of one pence per £100 nominal or 0.01. This gives a tick
size of £10.
The initial margin rate is £500 per contract.
The table below shows the VM over a period.
Date Trade Net Closing Daily Price Sett. Daily
price position price movement date settlement
1/06 109.13 1 109.09 4 ticks 2/06 £40 Loss
2/06 1 109.28 19 ticks 3/06 £190 Profit
3/06 1 109.28 No change 4/06 No Movement
4/06 1 109.35 7 ticks 5/06 £70 Profit
5/06 1 109.40 5 ticks 8/06 £50 Profit
8/06 109.42 0 2 ticks 9/06 £20 Profit
Total 29 ticks £290 Profit
The profit on the trade was 29 ticks or points, which is the difference
between the buying and selling price.
Each tick £10 therefore 29 £10 £290
The initial margin of £500 per contract would be called by the clear-
ing house on 2/6 and held until 9/6 when it would be returned.
It must be remembered that VM must always be settled in cash.
This is because the broker must always settle with the clearing
organisation in the currency of the contract. Clients without cash in
place to cover VM may incur harsh debit interest penalties.
130 Clearing and settlement of derivatives
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