How does SPAN Margin System work?
Option/Futures margin, very simply, is the money that a trader must deposit into his or her trading account in order to trade. This is in contrast to a margin on Equity, which is rather a loan to you from your broker so that you can buy more stock with lesser capital.
Next what we need to understand is that margin rules differ across various exchanges – which is to say that Chicago Board Options Exchange (CBOE) has a system completely different from what Chicago Mercantile Exchange (CME) uses to set its option margins. The later, along with the National Stock Exchange of India (NSE) and many other exchanges around the world use a system called SPAN.
SPAN (Standard Portfolio Analysis of Risk) Margin System is a methodology developed by CME (Chicago Mercantile Exchange) and used by many clearinghouses and exchanges to determine the sufficient amount that an Option and/or Future trader needs to have in their account to cover any potential losses.
Another related concept is that of Exposure Margin, which is the margin that is blocked over and above the beforementioned SPAN Margin to work as a cushion for any Mark-to-market losses.
Both SPAN and Exposure Margin – and hence also the Initial Margin (SPAN Margin + Exposure Margin) are specified by the Exchange.
Given above is a screenshot depicting calculation of Initial Margins by Zerodha using SPAN System to go long on 250 units of HDFC futures expiring on 20th April 2020.
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- The calculations of SPAN Margins are fairly complex and done using Risk Arrays.
- Risk Arrays are essentially hypothetical gain/losses of each contract under a specified set of market conditions from present to a set time in the future. Usually, they consist of 16 profit/loss scenarios for each of the contracts.
- The 16 scenarios are calculated based on the Combined Commodity’s Price Scan Range (the maximum underlying price movement likely to occur for the given timeframe) and the Volatility Scan Range (the maximum implied volatility change likely to occur for options).
- Each Risk Array scenario is comprised of a different market simulation, moving the underlying price up or down and/or moving volatility up or down. The risk array representing the maximum likely loss becomes the Scan Risk for the portfolio.
Given above is a snippet of how Scan Risk Arrays look like, taken from the CME Report.
Assume we have,
- Long 1 MAR 2019 SP Future (price is 2,790)4
- Short 1 MAR 2019 SP 2825 Call Option (implied volatility is 16%)
- The Price Scan Range is $30,000 or 120 points (CVF for SP 500 is $250, $30,000/$250 = 120 points)
- The Volatility Scan Range for SP 500 is 35%
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16th Scenario, with the highest Portfolio Gain/Loss, would be selected as the SPAN Risk Margin.
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What is the benefit of using the SPAN Margin System?
Assume we long 250 units of HDFC future expiring on 20th April 2020 as we did before, but also hedge that position by going short on 250 units of HDFC future expiring on 20th June 2020.
What we get is a total margin of Rs. 14,973, as opposed to Rs. 3,04,526 which is the margin before taking into account the margin benefit of Rs. 2,89,554. This happens because of our hedged position since long and short together are highly negatively correlated.
Author: Aman Aggarwal
About the Author: Aman is an Economics and Finance graduate with a budding interest in Strategic Management and Investment. An avid reader of all things Behavioral and Data Science –I strongly believe in solving problems with creative solutions backed up by quantitative rigor.