Tick size
The point was made earlier in the book that the tick size of a contract
is not always the same and there are therefore different ways that
they are arrived at.
Examples
Chicago Mercantile Exchange Standard & Poor’s 500 Index Future
• The contract size or trading unit is S&P Index X $250.
• The price is quoted in index points and the minimum price
fluctuation is 0.10 index points. This gives a tick size of $25
($250 divided by 10).
Euronext.liffe Short Sterling Interest Rate Contract
• The tick size is the value of a one-point movement in the con-
tract price. This price is arrived at by multiplying the notional
contract size by the length of time of the notional time deposit
underlying the contract in years multiplied by the minimum
tick size movement of 0.01 per cent.
£500 000 3/12 0.01 per cent £12.50
The tick size of the Short Sterling Future therefore £12.50
Option margin
The writers or holders of short positions in either calls or puts are
required to put up margin. The rationale behind this is that the
writer has an obligation and must either be able to buy back the
option position or be able to make or take delivery upon assignment.
However, there is a difference between the situation regarding calls
and puts.
The writer of a call option, if you recall, is required to deliver to the
buyer the underlying at the strike price of the option if the buyer exer-
cises their right. This means that the writer will either already have
possession of the underlying, i.e. they are a covered writer or will need
to purchase the underlying for onward delivery, i.e. they are a naked
writer.
The writer of a put option, on the other hand, is required to take
delivery of the underlying at the strike price of the option if the buyer
exercises their right. In this case the writer needs to have sufficient
capital to meet the purchase cost of the underlying.
Margin and collateral 131
The risk of course is that the writer cannot or does not meet their
obligation.
Option margin is often calculated by exchange clearing houses
using the previously mentioned TIMS. For example the OCC, Eurex
AG as well as, amongst many others, the Australian Clearing House
all use TIMS but it must be remembered that TIMS is not just about
calculating option margin anymore than SPAN is about futures mar-
gin; both calculate margins on ‘groups’ of products.
Methodology
The TIMS uses advanced pricing models to project the liquidation
value of each portfolio, given changes in the price of each underlying
product. These models generate a set of theoretical values based on
various factors including current prices, historical prices and market
volatility. Based on flexible criteria established by a clearinghouse,
statistically significant hedges receive appropriate margin offsets.
TIMS also is used to predict a member’s potential intra-day risk
under varying sets of assumptions regarding market changes.
TIMS organises all classes of options and futures relating to the
same underlying asset into class groups and all class groups whose
underlying assets exhibit close price correlation into product groups.
The daily margin requirement for a clearing member is calculated
based on its entire position within a class group and various product
groups. The margin requirement consists of two components, a MTM
component and an additional margin component.
Premium margin
The MTM component takes the form of a premium margin calculation
that provides margin debits or requirements for net short positions and
margin credits for net long positions. The margin debits and credits are
netted to determine the total premium margin requirement or credit for
each class group. The premium margin component represents the cost
to liquidate the portfolio at current prices by selling the net long posi-
tions and buying back the net short positions.
Additional margin
The additional margin component, the portion of the margin require-
ment that covers market risk, is calculated using price theory in
conjunction with class group margin intervals. TIMS projects the
theoretical cost of liquidating a portfolio of positions in the event of
132 Clearing and settlement of derivatives
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