an assumed worst case change in the price of the underlying asset.
Theoretical values are used to determine what a position will be
worth when the underlying asset value changes. Given a set of input
parameters (i.e., option contract specifics, interest rates, dividends
and volatility), the pricing model will predict what the position
should theoretically be worth at a specified price for the underlying
instrument.
The class group margin interval determines the maximum one-day
increase in the value of the underlying asset (upside) and the maxi-
mum one-day decrease in the value of the underlying asset (downside),
which can be expected as a result of historical volatility.
The methodology used to determine class group margin intervals
and product groups can be specified by each clearing institution.
Settlement of option margin
Operations teams need to be a bit careful in terms of what margin is
called and what is acceptable as collateral.
First, a clearing broker’s systems must be able to run the margin
system utilised by the exchange clearing houses of which they are
members. Huge problems in reconciliation and risk control will
occur if the margin calls cannot be agreed. In the same way an insti-
tutional client needs to be able to reconcile their broker’s margin
call.
Let us look at the case of a call option. If the trader or client has a
short position in, say, 20 BP Mar. 390 Call options with each option
contract being for 1000 shares and if the client has 20 000 BP
shares then they are fully covered in the event of assignment. They
could pledge those shares as good collateral over the full liability.
If BP share price, however, was only 360, a trader would be pretty
loathed to have to buy or hold 20 000 shares on their book as the
likelihood of the 390 calls being exercised is extremely low at this
point. This is where the concept of deltas mentioned earlier comes in,
and why systems like SPAN and TIMS which take into account the
out-of-the-money element of the risk are so good.
What about the writer of the puts?
It is clear here that the margin must reflect the cost of acquiring the
underlying. Therefore if the client wanted to put up say 20 000 BP
shares as collateral against 20 BP 390 Put options it cannot be fully
covered if the option is in-the-money.
Margin and collateral 133
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