The reason is simple enough to understand. BP shares are, say, cur-
rently 360p. Therefore 20 000 shares are worth £72 000; however, if
the option was assigned the writer would have to find 20 000 390
£78 000.
To be covered, either there would have to be more shares
deposited as collateral or the collateral would have to be ‘topped’
up with something additional like cash. Also the value of the collat-
eral must be monitored very carefully as the value could change
quickly and leave the margin call under-collateralised. For this rea-
son most brokers will agree with their client that the client should
leave a buffer in terms of collateral to avoid constant deposits and
withdrawals.
The broker may also propose something else to the client. If the
client wishes to deposit collateral in a form other than cash, the bro-
ker will probably charge some kind of administration fee. However,
this may be waived if the client agrees to rehypothecation. That is,
the client agrees to the transfer of the collateral to the broker to be
used however the broker wishes.
For some clients this is not a problem but for others it may be, and
operations teams within the client must understand the terms of any
collateral agreements they may have with their brokers.
Collateral
Initial margin obligations for futures and options positions at the
clearing house can be covered in various ways. Collateral in the form
of cash in the currencies of the contracts traded is most commonly
used. In addition, Bank Guarantees, Government Treasury Bonds
and Bills, Certificates of Deposits and certain Equities are accepted
at the London Clearing House for example. Each clearing house or
exchange will publish the collateral that they accept. LCH.Clearnet
has quite a wide range but some markets only accept cash in their
domestic currency.
It is possible to use a combination of cash and physical collateral in
some markets. For 10-Year Japanese Government Bond Futures in
the Tokyo Stock Exchange, however, only a maximum of 2 per cent
of the margin requirement may be covered using collateral and the
remaining 1 per cent must be cash.
The collateral that the broker will accept from a client is usually
negotiable. There may however be restrictions about where it must
be held and also an arrangement fee. In some cases, the client may
134 Clearing and settlement of derivatives
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