Classifications

• • G—PHYSICS
  • G06—COMPUTING OR CALCULATING; COUNTING
  • G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
  • G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
  • G06Q40/04—Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
• • G—PHYSICS
  • G06—COMPUTING OR CALCULATING; COUNTING
  • G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
  • G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• • G—PHYSICS
  • G06—COMPUTING OR CALCULATING; COUNTING
  • G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
  • G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
  • G06Q40/03—Credit; Loans; Processing thereof
• • G—PHYSICS
  • G06—COMPUTING OR CALCULATING; COUNTING
  • G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
  • G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
  • G06Q40/06—Asset management; Financial planning or analysis

Definitions

• Futures Exchanges such as the Chicago Mercantile Exchange Inc. (CME) provide a marketplace where futures and options on futures are traded. Futures is a term used to designate all contracts covering the purchase and sale of financial instruments or physical commodities for future delivery on a commodity futures exchange.
• a futures contract is a legally binding agreement to buy or sell a commodity at a specified price at a predetermined future time.
• Each futures contract is standardized and specifies commodity, quality, quantity, delivery date and settlement.
• An option is the right, but not the obligation, to sell or buy the underlying instrument (in this case, a futures contract) at a specified price within a specified time.
• an offset refers to taking a second futures or options on futures position opposite to the initial or opening position, e.g. selling if one has bought, or buying if one has sold.
• the Exchange provides a "clearing house" which is a division of the Exchange through which all trades made must be confirmed, matched and settled each day until offset or delivered.
• the clearing house is an adjunct to the Exchange responsible for settling trading accounts, clearing trades, collecting and maintaining performance bond funds, regulating delivery and reporting trading data. Clearing is the procedure through which the Clearing House becomes buyer to each seller of a futures contract, and seller to each buyer, and assumes responsibility for protecting buyers and sellers from financial loss by assuring performance on each contract. This is effected through the clearing process, whereby transactions are matched.
• a clearing member is a firm qualified to clear trades through the Clearing House.
• the Clearing House establishes clearing level performance bonds (margins) for all CME products and establishes minimum performance bond requirements for customers of CME products.
• a performance bond also referred to as a margin, is the funds that must be deposited by a customer with his or her broker, by a broker with a clearing member or by a clearing member with the Clearing House, for the purpose of insuring the broker or Clearing House against loss on open futures or options contracts. This is not a part payment on a purchase.
• the performance bond helps to ensure the financial integrity of brokers, clearing members and the Exchange as a whole.
• the Performance Bond to Clearing House refers to the minimum dollar deposit which is required by the Clearing House from clearing members in accordance with their positions.
• Maintenance margin refers to a sum, usually smaller than the initial performance bond, which must remain on deposit in the customer's account for any position at all times.
• the initial margin is the total amount of margin per contract required by the broker when a futures position is opened. A drop in funds below this level requires a deposit back to the initial margin levels, i.e. a performance bond call. If a customer's equity in any futures position drops to or under the maintenance level because of adverse price action, the broker must issue a performance bond/margin call to restore the customer's equity.
• a performance bond call also referred to as a margin call, is a demand for additional funds to bring the customer's account back up to the initial performance bond level whenever adverse price movements cause the account to go below the maintenance.
• the Clearing House dealing exclusively with clearing members, holds each clearing member accountable for every position it carries regardless of whether the position is being carried for the account of an individual member, for the account of a non-member customer, or for the clearing member's own account. Conversely, as the contra-side to every position, the Clearing House is held accountable to the clearing members for the net settlement from all transactions on which it has been substituted as provided in the Rules. [0015]
• the Clearing House does not look to non-member customers for performance or attempt to evaluate their creditworthiness or market qualifications.
• the Clearing House does monitor clearing members for the adequacy of credit monitoring and risk management of their customers.
• the Clearing House looks solely to the clearing member carrying and guaranteeing the account to secure all payments and performance bond obligations. Further, when an individual member executes orders for a clearing member, his or her guarantor clearing member is held accountable as principal for the brokered transaction until the transaction has been matched and recorded by the Clearing House as a transaction of the clearing member for whom the individual member had acted.
• CME risk management and financial surveillance techniques employed by CME are designed to:
• CME derives its financial stability in large part by removing debt obligations among market participants as they occur. This is accomplished by determining a settlement price at the close of the market each day for each contract and marking all open positions to that price, referred to as "mark to market.” Every contract is debited or credited based on that trading session's gains or losses. As prices move for or against a position, funds flow into and out of the trading account. Debt obligations from option contracts are also immediately removed, since the purchaser of an option must pay the premium (cost of the option) in full at the time of purchase. Sellers of options post performance bonds, discussed above, as determined by the CME according to the prevailing risk characteristics of the options sold. In the case of the CME, each business day by 6:40 a.m.
• CME's mark-to-the-market settlement system stands in direct contrast to the settlement systems implemented by many other financial markets, including the interbank, Treasury securities, over-the-counter foreign exchange and debt, options, and equities markets, where participants regularly assume credit exposure to each other. In those markets, the failure of one participant can have a ripple effect on the solvency of the other participants. Conversely, CME's mark-to-the-market system does not allow losses to accumulate over time or allow a market participant the opportunity to defer losses associated with market positions.
• a clearing member does not have sufficient performance bond collateral on deposit with the Clearing House, then the clearing member must meet a call for cash performance bond deposits by 6:40 a.m. and/or by 2:00 p.m. Chicago time, which results in a direct debit to the clearing member's account at one of CME's settlement banks.
• Clearing members' performance bond deposits may only be:
• IEF Interest Earning Facility
• IEF3 and IEF4 Clearing firm self-directed collateral management program, which allows collateral instruments allowable permitted under CFTC Regulation 1.25.
• CME also conducts stress testing of clearing member positions on a daily basis. Numerous stress scenarios have been modeled to reflect a diverse universe of possible market events. Stress results are evaluated against performance bond on deposit and also with clearing member adjusted net capital. Results of stress tests may lead the Clearing House to request that the clearing member provide additional information about its customer accounts such as whether there are non-CME offsetting positions in other markets. In some cases stress test results may cause the Clearing House to increase a clearing member's performance bond requirement, or reduce or transfer positions.
• Figure 1 depicts an exemplary risk management system according to one embodiment.
• Figure 2 depicts a block diagram of a risk management engine for use with the system of Figure 1.
• Figure 3 depicts flow chart showing exemplary operation of the risk management system of Figure 1, according to one embodiment.
• Figures 4A-4B depict exemplary performance bond requirements.
• CME establishes minimum initial and maintenance performance bond levels for all products traded through its facilities. CME bases these requirements on historical price volatilities, current and anticipated market conditions, and other relevant information. Performance bond levels vary by product and are adjusted to reflect changes in price volatility and other factors. Both initial and maintenance performance bonds are
• Maintenance performance bond levels represent the minimum amount of protection against potential losses at which the Exchange will allow a clearing member to carry a position or portfolio. Should performance bonds on deposit at the customer level fall below the maintenance level, Exchange rules require that the account be re-margined at the required higher initial performance bond level. Clearing members may impose more stringent performance bond requirements than the minimums set by the Exchanges. At the Clearing House level, clearing members must post at least the maintenance performance bonds for all positions carried. This requirement applies to positions of individual members, nonmember customers and the clearing member itself. [0034] In setting performance bond levels, the Clearing House monitors current and historical price movements covering short-, intermediate- and longer-term data using statistical and parametric and non-parametric analysis.
• CME calculates performance bonds using a system developed and implemented by CME called Standard Portfolio Analysis of RiskTM (SPAN®).
• SPAN bases performance bond requirements on the overall risk of the portfolios using parameters as determined by CME's Board of Directors, and thus represents a significant improvement over other performance bond systems, most notably those that are "strategy- based" or “delta-based.”
• Delta is the measure of the price-change relationship between an option and the underlying futures price and is equal to the change in premium divided by the change in futures price.
• SPAN simulates the effects of changing market conditions and uses standard options pricing models to determine a portfolio's overall risk. It treats
• SPAN licensed clearing organizations and exchanges determine for themselves the following SPAN parameters, in order to reflect the risk coverage desired in any particular market:
• Price Scan Range A set range of potential price changes
• Volatility Scan Range A set range of potential implied volatility changes
• Intra commodity Spread Charge An amount that accounts for risk (basis risk) of calendar spreads or different expirations of the same product, which are not perfectly correlated;
• Short Option Minimum Minimum margin requirement for short option positions
• SPAN combines financial instruments within the same underlying for analysis, and refers to this grouping as the Combined Commodity group. For example, futures, options on futures and options on equities on the same stock could all be grouped under a single Combined Commodity.
• SPAN To calculate a performance bond requirement, for each Combined Commodity in a portfolio, SPAN will:
• PC-SPAN is single-user desktop software that enables a user to enter positions manually or by using scripting language to automate the position entry process. With a click of the mouse, the SPAN requirement is known. As thousands of users can attest, PC-SPAN allows for an extremely quick, inexpensive and simple way to calculate margin requirements across multiple exchanges.
• the Span Risk Manager is a single-user, desktop software that integrates risk management features with the latest processing technology to deliver an extremely flexible, intuitive system for full portfolio risk management. Span Risk Manager's powerful features and intuitive design allow for true portfolio analytics through multi- variant stress testing and option exposures. [0046] Specifically, SPAN Risk Manager:
• TIMS Theoretical Intermarket Margin System
• Options Clearing Corporation located in Chicago, Illinois.
• TIMS allows clearing institutions to measure, monitor and manage the level of risk exposure of their members' portfolios.
• TIMS can calculate risk exposure at different account levels and for different account types.
• TIMS uses portfolio theory to margin all positions relating to the same underlying product and combines the risk of closely related products into integrated portfolios.
• This portfolio aspect of TIMS allows for the recognition of hedges used by market participants in increasingly interrelated markets.
• the TIMS methodology allows for measuring the monetary risk inherent in portfolios containing options, futures and options on futures positions.
• the additional margin component 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 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.
• TIMS computes a coefficient of determination. TIMS assigns class groups to a product group when the value of the coefficient between the class groups is within policy limits established by the clearinghouse. The product group percentage or offset is established based on the lowest coefficient of determination among all of the class groups included in the product group.
• this specified percentage of any margin credits at the class group level is used to offset margin requirements generated by other class groups in the same product group.
• OMS II Yet another risk management system is the OMS II system, also referred to as the "Window method” or the “Vector method”.
• OMS II is the OM risk calculation method for calculating margin requirements. It is included in the risk valuation or RIVA system within OM SECUR. It was constructed in order to handle non-linear instruments in a better way than SPAN or TIMS. OMS II calculates worst case loss scenarios, store these in vectors, adjust for spreading, and adds the vectors in a way that takes correlation in to account.
• the scenario with no price move at all is the middle scenario and around it there are 15 up and 15 down scenarios (or (n-l)/2 up and (n-l)/2 down scenarios).
• Each valuation point is saved in a 31x3 matrix, that is, each row contains a price move and the three volatility fluctuations.
• the matrix is expanded to a 31x6 matrix so that the case of both a bought and a sold contract is represented in the matrix, this because of additional fine-tunings that are available in OMS II.
• the matrixes are saved for use when margin requirements of portfolios are calculated.
• the different instruments are sorted into a number of groups, called window classes.
• the window classes have a window size defined in percent. When the percentage goes down the correlation goes up and vice versa, e.g. a window size of 0% means that the instruments in the window class are totally correlated and a window size of 100% means that the instruments in the window class are uncorrelated.
• a window class to be a member of another window class, and in such case creating a tree structure of more complicated correlations.
• To calculate the margin for a portfolio the window is moved from left to the right over the entire valuation interval for all window classes, starting with the ones in the bottom of the tree. The window is centered over each valuation point.
• a spread is the price difference between two contracts, e.g., holding a long and a short position in two related futures or options on futures contract, with the objective of profiting from a changing price relationship or the assumption of a long and short position on the same business day in the same or related commodities for the same account.
• Long refers to one who has bought a futures or options on futures contract to establish a market position and who has not yet closed out this position through an offsetting procedure, e.g. one who has bought a futures or options contract to establish a market position; a market position which obligates the holder to take delivery; or one who owns an inventory of commodities. Long is the opposite of short.
• a Spread order - Open Outcry is an order that indicates the purchase and sale of futures contracts simultaneously.
• a Spread trade is the simultaneous purchase and sale of futures contracts for the same commodity or instrument for delivery in different months or in different but related markets.
• a spreader is not concerned with the direction in which the market moves, but only with the difference between the prices of each contract.
• Spreads include Bear spreads, Bull Spreads, Butterfly spreads, Calendar spreads and user defined spreads.
• a Bear spread is a vertical spread involving the sale of the lower strike call and the purchase of the higher strike call, called a bear call spread.
• a vertical spread involving the sale of the lower strike put and the purchase of the higher strike put called a bear put spread.
• a Bull spread is a vertical spread involving the purchase of the lower strike call and the sale of the higher strike call, called a bull call spread.
• a vertical spread involving the purchase of the lower strike put and the sale of the higher strike put called a bull put spread.
• Butterfly spreads can be futures or options spreads. As an option spread, a Butterfly spread is a strategy combining a bull
• SPAN requirements i.e., the risk performance bond (margin) requirements obtained using the Standard Portfolio Analysis of Risk system or the SPAN calculation algorithm, utilizing the disclosed embodiments, is described below in detail.
• the SPAN algorithm has always been viewed as being applicable to an unlimited range of product types, but the original focus in its implementation has been on standardized futures, options on futures and options on physicals. Portfolios today, however, can contain the widest range of derivative and non-derivative instruments.
• SPAN 4 supports the ultimate in product flexibility using an advanced, object-oriented model. In particular, SPAN 4 adds support for equity securities and debt securities (stocks, bonds, etc.), and options thereon.
• Account types Portfolios of positions to be margined using SPAN are held in performance bond accounts, or margin accounts. The positions in an account constitute a single portfolio.
• SPAN calculations may be done for particular customer or other accounts of firms which are clearing members, directly or indirectly, of one or more clearing organizations. These are firm-level, also called customer-level, calculations. [0084] For any performance bond account, the account type is defined by:
• a business function represents a particular purpose for which an exchange or clearing organization using SPAN wishes to perform the SPAN calculation or have it performed, at either the clearing-level or the customer-level. For example:
• a clearing-level SPAN calculation for a portfolio is always for a specific business function.
• the portfolio is identified with a specific business function, and may contain only products eligible for that business function.
• a customer-level portfolio may have any number of business functions represented within the portfolio.
• CME represents the exchange complex acronym for normal processing for the CME clearing organization
• Performance bond classes are used generically to designate different levels of SPAN requirements.
• the first class (the one with the lowest requirement level) is specially designated as the core class and the second class (the one with the next-highest requirement level) as the reserve class.
• SPAN For each business function within a portfolio for which the SPAN calculation is being done, for each combined commodity represented within that business function, SPAN yields one or more SPAN risk requirements. Each such requirement corresponds to a specific SPAN requirement level — a specific performance bond class and an initial or maintenance designation.
• Performance bond currencies For each combined commodity, a single currency is specified as the performance bond currency for that combined commodity.
• SPAN publish, at least once daily, one or more SPAN risk parameter files. For simplicity, these are typically referred to as SPAN files.
• SPAN risk parameters may be generically defined as the set of data needed to calculate SPAN requirements, other than the actual portfolios for which the requirements are to be calculated.
• SPAN risk parameters consist of (a) product data and
• SPAN risk parameter files contain data for exactly one point in time. In effect, they contain data to be used for performance bond calculations for portfolios existing at that point in time.
• the SPAN file contains data for one or more business functions of the exchange or clearing organization publishing the file.
• the file will contain data for each combined commodity defined for the business function.
• a risk array for a particular contract contained with a typical customer-level SPAN file may be designated as being for a hedge customer account, for the core performance bond class, and the maintenance requirement.
• Some clearing organizations may publish more than one SPAN file for the end-of-day settlement. These are typically distinguished as being for:
• the lookahead time reflects the amount of time into the future from the current time, for which the SPAN requirement levels are intended to protect against declines in portfolio value.
• Lookahead time is a parameter of SPAN and may be set to any desired value. There are two methods, however, which are typically in use for its specification:
• the lookahead time is typically set to one business day in a business year assumed to have 250 business days per year, or 0.004 years.
• the values of the price movement, the volatility movement, and the covered fraction are determined by the scan point definitions and the two scan ranges — the price scan range and the volatility scan range. These values are the key inputs to
• Each scan point definition consists of:
• the price scan magnitude may itself be expressed in terms of a price scan numerator, a price scan denominator, and a price scan direction.
• a price scan magnitude of -.3333 may be expressed as a numerator of one, a denominator of three, and a direction of down.
• the volatility scan magnitude may be expressed in terms of a volatility scan numerator, a volatility scan denominator, and a volatility scan direction.
• SPAN 4 allows the definition, for each combined commodity of as many sets of scan points as may be desired, each for a different account type and requirement level. The definitions must be identical, however, for sets of combined commodities which have intercommodity spreads defined among them.
• the actual model selected, the parameters of the model, the interest rates, and the look-ahead time are all parameters of SPAN.
• a directly calculated SPAN requirement is a requirement, at a particular performance bond requirement level, for which the full SPAN calculation is done — i.e., scanning, spreading, etc.
• An indirectly calculated requirement is one that is derived from another requirement, at a different requirement level, by the application of a simple multiplicative
• SPAN requirements are calculated for the levels defined for this selected account type.
• Risk adjustment factors and derived requirements For each combined commodity, any number of risk adjustment factors may be provided in the SPAN risk parameter file.
• Each contract (product) which is not a physical of one or another type is classified as a derivative, and has one or more underlying contracts.
• Derivative products that have exactly one underlying contract are known as non-combination derivatives.
• Participation of product families in business functions A product family is said to participate in a particular business function, if it has been assigned to one of the combined commodities defined for that business function.
• a tier in SPAN is a contiguous range of delta periods within a combined commodity.
• scan rate tiers the specification of tiers for defining price scan ranges and volatility scan ranges
• Specific tiers of a particular type for a combined commodity are always identified by a tier number beginning with one, and are further qualified by a beginning period code and an ending period code.
• the ending period code must be greater than or equal to the beginning period code, and the delta periods for the different tiers never overlap.
• Portfolios may be defined at either the clearing-level or the customer-level.
• a gross position is determined by the beginning of day position and, for each trade done for that day, whether it was an opening (new) or closing (liquidating) transaction.
• Net margining At the firm-level and often at the clearing-level, portfolios are typically “net margined.” This is also typically called “calculating a net requirement.”
• the position is kept gross — i.e., if the position may be simultaneously long and short — then it is first netted before being processed in SPAN. Only the portfolio of net positions is margined.
• the firm with the omnibus account is said to carry the omnibus account on its books, and is often called the "carrying firm.”
• the individual accounts on the first firm's books are said to be "subaccounts" of the omnibus account.
• the carrying firm typically calculates a net requirement for each subaccount, and the total omnibus account requirement is simply the sum of the subaccount requirements.
• an omnibus account portfolio may be only “partially disclosed”, or “non-disclosed.”
• the omnibus account has provided information to the carrying firm about some sets of subaccounts, but not of all. If non-disclosed, no information is provided about the subaccounts and which positions they hold.
• each gross omnibus account position which is not held in disclosed subaccounts, is typically said to be "naked". In other words, for each position — total long and total short — there is a naked portion - the naked long and naked short.
• a separate SPAN requirement is calculated for each naked long position quantity, and for each naked short position quantity. Because each such position quantity is in a single contract, and is only on one side of the market, there are no risk offsets recognized in such requirements.
• the total requirement for the naked portion of the account portfolio is the sum of all of these individual naked long and naked short requirements.
• Positions are kept gross - i.e. may be simultaneously long and short.
• intercommodity spreadable Some portion of the total long and total short for each position is broken out, and margined net. This portion is termed the fully inter-commodity spreadable long and short, and is often referred to as the “intercommodity spreadable” or the “inter- spreadable” long and short, or as just the “inter positions.”
• Clearing-level gross margining is typically used for customer-origin performance bond accounts where the clearing-level positions are determined by aggregating positions across many individual customer accounts. Typically, the positions within each customer account are inspected to determine whether risk offsets exist both within and between commodities, or only within commodities, or not at all. Based on this inspection, the customer's positions are classed as inter-spreadable, inter-spreadable, or naked. The total clearing-level inter-spreadable long and short positions, then, are calculated as the sum of the customer positions that were classed as inter-spreadable, and analogously for the intra-spreadable positions.
• positions in products eligible for participation in a particular cross-margin agreement may be routed to a performance bond account specifically for that cross-margin business function, whereas positions in other products, not eligible for this cross-margin agreement, are routed to a performance bond account specified as being for the normal business function.
• compositions to be margined or “dispositions”, each of which is designated for a particular performance bond account and hence to be margined via the SPAN parameters for a specific business function.
• a total gross position of 100 long and 200 short in a product eligible for a particular cross-margin agreement might have dispositions for it of 50 long
• the SPAN calculation for net portfolios contains the description of the detailed algorithm for calculation of a SPAN risk requirement for each combined commodity represented in a portfolio to be margined on a net basis — a so- called "net portfolio.” This may be either a customer-level portfolio or a clearing-level portfolio.
• Position processing in SPAN consists of processing each position within each combined commodity represented in the portfolio, for the purposes of:
• Short option minimum calculation determining the effect of the position on the quantity for determination of the short option minimum charge (also called the minimum commodity charge).
• Position value calculation evaluating the current monetary value of each position, and incrementing the overall current monetary values for the combined commodity, broken out by whether the position is long or short and by whether the contract is valued futures-style or premium-style.
• Position types for the position value calculations Products can be categorized by whether their valuation method is futures-style or premium- style:
• Futures contracts are valued futures-style; the daily mark to market and the daily payment or collection for settlement variation (sometimes called "variation margin") is what distinguishes them from a forward contract.
• Option positions are typically valued premium-style, but some exchange- traded options are valued futures-style.
• the exchange or clearing organization using SPAN may establish a business rule regarding the timing of the recognition of value for premium-style products. For example, suppose an unsettled trade for a stock done for the current business day is included in the portfolio of positions to be margined, and that this trade will settle three days subsequently. In this case, the clearing organization might decide not to give full or even partial credit for the premium value of this trade until it has settled and the full premium has been paid or collected. If so, the total premium value used for the purpose of determining whether a margin excess or deficit exists, should be adjusted by the amount of this premium value for which credit is not being given. [00245] Special position-processing features: In addition to regular position processing, SPAN supports several special position-processing features which provide additional power and flexibility:
• Split Allocation is typically used for positions in combinations and/or options on combinations where the underlying instruments of the combination are in different physical commodities.
• the position in the combination or the option on the combination is split out (allocated) into positions on the underlying instruments of the combination.
• Delta-Split Allocation is typically used for positions in combinations and/or options on combinations where the underlying instruments of the combinations are at different expirations within the same physical commodity.
• position quantities Depending on the types of instruments in the portfolio and the conventions used for expressing their positions, it is possible for position quantities to be fractional — i.e., not whole numbers.
• Pre-Processing for Margining Debt Securities on an Equivalent Basis For positions in physical debt securities, which are being margined on an equivalent basis, it may be necessary to perform special pre-processing to express the position quantities properly, even before the transformation of the debt securities position into its equivalents. This section describes that pre-processing.
• positions should be expressed in units of thousands of par value currency units in the currency of denomination. For example, a position in a U.S. Treasury Bond with a face value of $1,000,000 should be expressed as 1,000.
• Positions to be margined in such physical debt securities are those resulting from not-yet-settled trades.
• the actual position in such securities can sometimes be broken out as the sum of:
• split allocation is typically used for positions in options on futures intercommodity spreads.
• the method is generically applicable, however, to any combination product or option on combination product.
• split allocation is to be performed for a product family linked into a combined commodity. Not all product families linked into a combined commodity need be processed using split allocation. In general, however, for the algorithm to yield the desired results, split allocation should be specified for both the options on the combination, and the combination itself. Typically both of these product families will be placed into the same combined commodity.
• the total position is equal to the sum of the position in the contract itself, the equivalent position, and the position resulting from split allocation.
• the marginable position is equal to the total position times the contract-scaling factor.
• the position for valuation is the sum of the position in the contract itself and the rounded position resulting from equivalents.
• the number of short calls is equal to the absolute value of the product of the marginable position and the delta-scaling factor. The number of short puts is zero.
• the number of short puts is equal to the absolute value of the product of the marginable position and the delta-scaling factor.
• the number of short calls is zero.
• the Liquidation Risk calculation is a method of determining the Scan Risk, which has been introduced in SPAN for the Paris Bourse (SBF.) This calculation requires the determination of a special position value called the Liquidation Risk Position Value. As can be seen, this differs from the regular position value in that (a) it includes any position quantity resulting from split allocation, and (b) for positions in debt securities, it is adjusted for the duration of the security.
• Intercurrency risk scanning is an optional feature of the scan risk calculation which may be applied in cases where there are products whose settlement currency is different from the performance bond currency of the combined commodity into which they are linked.
• ⁇ ⁇ ⁇ For a given settlement currency and performance bond currency pair, read the intercurrency scan rate up and the intercurrency scan rate down. (These are provided in the London format SPAN file on the currency conversion rate record for that currency pair.) Express these values as decimal fractions. If the settlement currency is equal to the performance bond currency, take zero for these values. ⁇ J* Take the exchange rate multiplier, which converts a value in the settlement currency to one in the performance bond currency. If the settlement currency is equal to the performance bond currency, take one for this value.
• the position value is long (positive) or short (negative).
• Spread groups The SPAN algorithm supports the definition of the following groups of spreads:
• Intra-commodity spreads and inter-commodity spreads are the most familiar types.
• each clearing organization involved in a particular spread is free to recognize or not recognize that spread, and to specify the particular credit rate applicable to its own products. This may be used when a clearing organization wishes to grant a reduction to the performance bond requirement for its own products when the risk of those products is reduced by offsetting positions on another clearing organization,
• Super-intercommodity spreads are a new spread group created in order to allow the recognition of particular delta patterns across combined commodities, even before intracommodity spreading is performed. For example, this type of spread can be used to recognize a "tandem" relationship between two combined commodities (for the first combined commodity: long in one month, short in another; and for the second combined commodity: short in one month, long in another.)
• Cross-margining spreads are a new group created in order to allow two or more clearing organizations which participate in a cross-margin agreement, to define spreads which are to be evaluated before normal intra- and inter-commodity spreading is done.
• the new pre-cross-margining spread group gives those same clearing organizations an opportunity to define spreads which are to be evaluated first, before the cross- margining spreading is done.
• Spread types hi addition to the spread group in which they are contained, spreads may be categorized by whether they are delta-based, scanning-based, or hybrid delta-based / scanning-based.
• Scanning-based spreads and hybrid spreads can only be used for the intercommodity spread groups ⁇ pre-crossmargin spreads, super-intercommodity spreads, and normal intercommodity spreads.
• a delta-based spread is one that is formed on a delta-basis - i.e., according to the relative magnitudes and relationships of the remaining delta values for each of the legs of the spread.
• a delta-based spread may contain any number of spread legs. Spreads are typically two-legged, but three, four, five or more legged-spreads may occur. [00300] Each leg references a specific combined commodity, and for that combined commodity, one of:
• the relative market side indicator is either A or B, and indicates the relative relationship of the remaining deltas of the legs which must prevail in order for spreads to be formed. For example, for a typical two-legged A to B spread, either the remaining delta for the first leg must be positive and the second leg negative, or the remaining delta for the first leg must be negative and the second leg positive.
• a delta-based spread also has defined for it a charge or credit method — either flat-rate, or weighted price risk:
• a charge for the spread is calculated by taking the number of spreads formed and multiplying by the charge rate.
• Weighted price risk is typically used for intercommodity spreads. For each participating leg, a credit for the spread is calculated by determining the total number of delta consumed by the spread, times the weighted price risk (which can be thought of as the price risk per delta), times the credit rate percentage.
• a delta-based spread also has defined for it one or more rates, depending on how many requirement levels are being directly calculated.
• Delta-based spreads using the flat rate method may have more than one combined commodity represented among their legs. If so, the resulting charge is apportioned to each leg according to the relative proportion of the absolute value of its delta per spread ratio. All such combined commodities participating in such a spread must accordingly share the same performance bond currency. [00309] Spreads within spreads: Sometimes it may be desired to use one delta- based spread to set a limit on the total number of spreads formed via a separate set of delta-based spreads.
• a delta-based spread may contain a set (one or more) of delta-based spreads, each of which may contain a set (one or more) of delta-based spreads. There are no limits to the numbers of levels of such recursions.
• top-level spread The spread at the top of such a hierarchy is called the top-level spread, and it is the one that contains the rate(s) for the spread. Spreads at lower levels do not have rates defined for them.
• Each clearing organization can only provide a credit for its own products, hi this example, when clearing organization X specifies the spread, the credit rate(s) it specifies only apply to its own products. And similarly for clearing organization Y.
• X may specify one rate applicable to its products
• Y may specify a different rate applicable to its products
• Last determine the charge or credit associated with the spreads formed.
• ⁇ ⁇ ⁇ Initialize the remaining delta to be removed, as the delta to be consumed. ⁇ * ⁇ If the leg references a spread tier — either an intracommodity or an intercommodity spread tier, and either a specific tier or the overall tier:
• leg references an intercommodity spread tier, select that tier.
• Scanning-Based Spreads are inherently intercommodity spreads, and can only be present within the three spread groups which (a) include more than one combined commodity among the legs and (b) do not cross exchange complexes. These groups are: pre-crossmargin spreads, super-intercommodity spreads, and normal intercommodity spreads.
• a scanning-based spread is similar to a delta-based spread in that it contains a collection of legs. Each leg, however, references only a specific combined commodity.
• the relative market side indicator is not applicable to the legs of a scanning-based spread.
• the delta per spread ratio is applicable, but, as will be described
• One of the legs of a scanning-based spread is designated as the target leg, and there is an associated parameter of the target leg called the target leg required flag:
• the target leg required flag is true, then the combined commodity designated as the target leg must be present in the portfolio in order for the spread to be formed, and if it is not, the spread is skipped.
• leg-required flag For each leg which is not the target (a "non-target leg"), there is a parameter called the leg-required flag. If any non-target leg which is specified as required is not present in the portfolio, then the spread is skipped. In other words, all required non-target legs must be present in the portfolio in order for the spread to be formed.
• a scanning-based spread has one or more credit rates specified for it, for different account types and requirement levels for those account types.
• Evaluating a Scanning-Based Spread Verify that all of the required legs are represented in the portfolio. Skip the spread if not.
• this leg is not the target, and if the performance bond currency for this leg is different from the performance bond currency for the target leg, then convert the value to the performance bond currency of the target.
• Hybrid Delta-Based / Scanning-Based Spreads A hybrid delta-based / scanning-based intercommodity spread combines elements of delta-based spreading and scanning-based spreading.
• Hybrid spreads may be present only in the normal intercommodity spread group, or the pre-crossmargining spread group.
• delta-based spread part of the hybrid spread definition will contain a collection of delta-based spread legs. There are several restrictions, however, on the specification of the spread and of its spread legs:
• the spread is not recursive — i.e., it may not contain a subsidiary collection of delta-based spreads.
• Each spread leg may reference only the overall intercommodity spread tier of a specific combined commodity. References to specific intercommodity spread tiers or to delta periods are not allowed.
• a charge rate must be specified for the delta-based spread, which rate is denominated in that same performance bond currency.
• a hybrid spread will also specify a target leg, which will reference a specific combined commodity. This target combined commodity is never one into which any products are linked. It is not referenced by any spread until the hybrid spread for which it is specified as the target. After this spread, it may subsequently participate in intercomrnodity spreading, but only as a leg of a regular delta- based spread.
• Weighted price risk has been determined for the overall intercommodity spread tier on the target.
• the overall intercommodity spread tier of the combined commodity which was the target of the original hybrid spread, may participate as a leg of other delta-based intercommodity spreads using the weighted price risk method of determining the credit.
• the intercommodity spread credit for the original target leg calculated as a result of that delta-based spread is apportioned back to the original non- target legs of the original hybrid spread, in proportion to the scan risk for that leg to the total scan risk.
• the result is the SPAN risk requirement for this requirement level.
• the third to last step is called capping the risk at long option value for portfolios consisting solely of long options. Note that the value at which the risk is capped may include both futures-style options and premium-style options. The key factor here is not how the options are valued, but whether they are long positions in products for which the current value of the risk is limited to the current value of the positions themselves.
• risk adjustment factors used to determine derived requirements are used to determine an initial requirement level from a maintenance requirement level.
• a gross-margined firm-level account is any such account for which naked long and naked short positions are margined in this manner.
• An omnibus account may be considered to be an example of such an account for which there may also be positions in defined subaccounts.
• the Total Long position must be at least as great as the sum of the subaccount positions that are net long
• the Total Short position must be at least as great as the absolute value of the sum of the subaccount positions that are net short. Naked position quantities may be zero, but by definition they may never be negative.
• SPAN calculation for the omnibus account in that it ensures that the subaccount requirements will be available for aggregation to the omnibus account when they are needed.
• Naked Position SPAN Evaluation Algorithm As described above, this algorithm is described to either the naked long quantity or the naked short quantity of a position held in a gross-margined account, either at the firm-level or the clearing-level. ⁇ ⁇ ⁇ Create a net portfolio for the purpose of this calculation, consisting solely of this naked long (or naked short) position. ⁇ Apply the SPAN algorithm to this net portfolio. ⁇ ⁇ ⁇ For each requirement level directly calculated:
• positions are maintained on a gross basis. For any particular position in the portfolio, a Total Long position and a Total Short position are defined.
• the naked long quantity is then determined by subtracting the intracommodity spreadable long quantity and the intercommodity spreadable long quantity from the total long quantity, and analogously for the naked short quantity.
• the total long quantity must always be the sum of the intracommodity spreadable long, the intercommodity spreadable long, and the naked long.
• the total short must always be the sum of the intracommodity spreadable short, the intercommodity spreadable short, and the naked short.
• the result is the specified value, for the specified class, for the specified performance bond currency, for the specified report group with the specified exchange complex.
• the SPAN algorithm determines the SPAN requirements and available net option value for the different requirement levels for each combined commodity within the portfolio, and aggregates of these values to the report group, exchange complex and total portfolio levels, both by performance bond currency represented and as equivalent values in the portfolio currency.
• performance bond value of non-cash collateral assets. This value is typically called the securities on deposit. ⁇ Determine the net value in the portfolio currency of cash in the account due to gains

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