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span-methodology CME SPAN® Standard Portfolio Analysis of Risk® © 2010 CME Group. All rights reserved 2 • Developed in 1988 by Chicago Mercantile Exchange Inc. to effectively assess risk on an overall portfolio basis. • SPAN is a market simulation based Value At Ri...

span-methodology
CME SPAN® Standard Portfolio Analysis of Risk® © 2010 CME Group. All rights reserved 2 • Developed in 1988 by Chicago Mercantile Exchange Inc. to effectively assess risk on an overall portfolio basis. • SPAN is a market simulation based Value At Risk system which has been reviewed and approved by market regulators and participants world wide. • SPAN is the official Performance Bond mechanism of 54 exchanges and clearing organizations world-wide, making it the global standard for portfolio margining. • SPAN’s risk based margin requirements allows for effective margin coverage while preserving efficient use of capital. • SPAN assesses risk for a wide variety of financial instruments including: futures, options, physicals, equities, or any combination. CME SPAN® - Standard Portfolio Analysis of Risk © 2010 CME Group. All rights reserved 3 • SPAN assesses the risk of a portfolio, by calculating the maximum likely loss that could be suffered by the portfolio based on parameters set by the margin-setting authority, usually an exchange or clearing organization. • The core of SPAN risk analysis is to simulate potential market moves and calculate the profit or loss on individual contracts given the market moves. • Exchanges may determine any number of market scenarios to be included in the SPAN analysis. • Most SPAN exchanges and clearing organizations use 16 scenarios. CME SPAN® - Objectives © 2010 CME Group. All rights reserved 4 • SPAN groups together financial instruments with the same underlying for analysis. • For example, Futures on an Equity Index and Options on the Equity Index would be grouped together for analysis. • Each product is referred to as a Combined Commodity. • SPAN uses parameters set by the exchange or clearing organization to evaluate a portfolio with the following two step analysis: Step 1: SPAN first analyzes the risk of each Combined Commodity in isolation from other Combined Commodities. Step 2: SPAN then seeks risk reducing offsets between Combined Commodities. CME SPAN® - Methodology Scan Risk Arrays © 2010 CME Group. All rights reserved 6 • The core of SPAN risk analysis to simulate potential market moves and calculate the profit or loss on individual contracts. • Exchanges or clearing organizations may determine any number of market scenarios to be included in SPAN analysis. • Most SPAN exchanges or clearing organizations use 16 scenarios. • The 16 scenarios are referred to as SPAN Risk Arrays. CME SPAN® - Scan Risk © 2010 CME Group. All rights reserved 7 • SPAN Risk Arrays represent a contract's hypothetical gain/loss under a specific set of market conditions from a set point in time to a specific point in time in the future. • Risk Arrays typically consist of 16 profit/loss scenarios for each contract. • 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. CME SPAN® - Scan Risk Arrays © 2010 CME Group. All rights reserved 8 • The next slide demonstrates the Scanning Risk calculation for an S&P500 portfolio: Long 1 Sep 2010 SP Futures (price is 1100) Short 1 Sep 2010 SP 1000 Call Option (implied volatility is 28%) • The Price Scan Range is $22,500 or 90 points (CVF for SP500 is $250, $22,500/$250 = 90points) • The Volatility Scan Range for SP500 is 7% CME SPAN® - Scan Risk Example © 2010 CME Group. All rights reserved 9 CME SPAN® - Scan Risk Example Scenario SP Underlying Price Move Volatility Move SP Future Gain/Loss SP Option Gain/Loss Portfolio Gain/Loss 1 UNCHANGED UP 0 1,807 1807 2 UNCHANGED DOWN 0 -1,838 -1,838 3 UP 33% UP -7,499 7,899 400 4 UP 33% DOWN -7,499 5,061 -2,438 5 DOWN 33% UP 7,499 -3,836 3,663 6 DOWN 33% DOWN 7,499 -8,260 -761 7 UP 67% UP -15,001 14,360 -641 8 UP 67% DOWN -15,001 12,253 -2,748 9 DOWN 67% UP 15,001 -8,949 6,052 10 DOWN 67% DOWN 15,001 -13,980 1,021 11 UP 100% UP -22,500 21,107 -1,393 12 UP 100% DOWN -22,500 19,604 -2,896 13 DOWN 100% UP 22,500 -13,455 9,045 14 DOWN 100% DOWN 22,500 -18,768 3,732 15 UP 300% UNCHANGED -22,275 21,288 -987 16 DOWN 300% UNCHANGED 22,275 -9,160 13,115 Largest Potential Loss = SPAN Risk 13,115 © 2010 CME Group. All rights reserved 10 • Deep out-of-the-money short options may pose significant risk, as unusually large price changes may result in unexpectedly large losses, particularly as expiration nears. • SPAN accounts for this risk by including Extreme Scenarios in the Risk Arrays. • Extreme Scenarios may be used to simulate a significant market move designed to shock deep out-of-the-money options. • Extreme Scenarios are determined by the Exchange or Clearing Organization. • CME uses a market move equal to 3 times the Price Scan Range for a given product. The resulting gain or loss is then multiplied by a percentage of 33% to determine the potential exposure. CME SPAN® - Scan Risk Extreme Scenarios © 2010 CME Group. All rights reserved 11 CME SPAN® - Composite Delta Scenarios Scenario Underlying Price Change as % of Price Scan Range Probability Weight 1 UNCHANGED 0.27 3 UP 33% 0.217 5 DOWN 33% 0.217 7 UP 67% 0.11 9 DOWN 67% 0.11 11 UP 100% 0.037 13 DOWN 100% 0.037 • Composite Delta is derived as the weighted average of the deltas, where the weights are associated with each underlying price scan point. • Below is an example of the 7 Delta Points used by CME: SPAN® Analysis Spread Types & Formations Short Option Minimum & Delivery Add-On Charge Net Option Value © 2010 CME Group. All rights reserved 13 • Intra-Commodity Spread : Evaluate the basis risk between contract periods with different expirations within the same product. Spreads are prioritized by lowest charge. • Inter-Commodity Spread : Evaluate credit available for offsetting positions in related instruments. Spreads are prioritized by greatest total savings. • SPAN forms Intra-Commodity Spreads before Inter-Commodity Spreads. • Super Inter-Commodity Spread : Allows Inter-Commodity Spreads to be evaluated before Intra-Commodity Spreads. • Inter-Exchange Spread Credit: Allows spreads to be formed for portfolios containing products listed on multiple Exchanges, as defined by the Exchange. The formation of Inter-Exchange Spreads is similar to process of forming Inter-Commodity Spreads, however each Exchange can only provide a credit for its own products. CME SPAN® - Spread Types & Formation © 2010 CME Group. All rights reserved 14 • Since futures prices do not correlate exactly across contract months, a gain in one month may not exactly offset losses in another month. • An Intra-Commodity Spread Charge can be set in SPAN to cover the risk of calendar spread positions. • The Intra-Commodity Spread Charge can be tailored for contract pairs or specified groups of contracts. • There is no limit to the number of contract legs that can be specified in an Intra- Commodity Spread, also known as tiered intra-commodity spreading. • The Intra-Commodity Spread Charge can also be tailored to specific calendar months. • For example, a March versus September calendar spread can have a different charge rate than a March versus December calendar spread. This is also known as series specific intra-commodity spreading. • The next slide shows an example of an Intra-commodity Spread for a portfolio with 1 long September 2010 and 1 short September 2010 Eurodollar. CME SPAN® - Intra-Commodity Spread Risk © 2010 CME Group. All rights reserved 15 • The Intra-Commodity Spread Charge for Nov 2010 vs. Dec 2010 is $200. • Since the gains on Nov ED exactly offset the losses on Dec ED, the Scan Risk is $0. • Therefore, the Intra-Commodity Spread Charge of $200 becomes SPAN Risk. CME SPAN® - Intra-Commodity Spread Example Scenario SP Underlying Price Move Volatility Move Nov ED Gain/Loss Dec ED Gain/Loss Portfolio Gain/Loss 1 UNCHANGED UP 0 0 0 2 UNCHANGED DOWN 0 0 0 3 UP 33% UP -250 250 0 4 UP 33% DOWN -250 250 0 5 DOWN 33% UP 250 -250 0 6 DOWN 33% DOWN 250 -250 0 7 UP 67% UP -500 500 0 8 UP 67% DOWN -500 500 0 9 DOWN 67% UP 500 -500 0 10 DOWN 67% DOWN 500 -500 0 11 UP 100% UP -750 750 0 12 UP 100% DOWN -750 750 0 13 DOWN 100% UP 750 -750 0 14 DOWN 100% DOWN 750 -750 0 15 UP 300% UNCHANGED -743 743 0 16 DOWN 300% UNCHANGED 743 -743 0 © 2010 CME Group. All rights reserved 16 CME SPAN® - Inter-Commodity Spread Risk Combined Commodity Position Outright PB Requirement Recognize Spread Credit SPAN Requirement SP Long 1 $22,500 NP Short 2 $14,000 x 2 = $28,000 Total $50,500 X 85% = $42,925 $7,575 • To recognize the risk reducing aspects of portfolios containing off-setting positions in highly correlated instruments, SPAN forms Inter-Commodity Spreads. • Inter-Commodity Spreads produce credits which reduce the overall performance bond or margin requirement. • The universe of recognized spreads, rates, and priority are determined by the Exchange. • Below is an example of 1 Long SP future and 2 Short Nasdaq futures. The recognized spread ratio is 1 SP vs. 2 ND and the spread credit is 85%. © 2010 CME Group. All rights reserved 17 • Delta Based Spreading is performed after the Scan Risk or Scanning process. • One result of the Scanning process for each Combined Commodity is a Net Delta position, which is an estimate of market exposure that has not been offset within the Combined Commodity which is available to be offset between Combined Commodities. • Each exchange defines a table of recognized Inter-Commodity Spread formations and the margin credit to apply for such formations. • SPAN takes the Inter-commodity spread table and seeks out the defined spread formations, giving margin credit for each spread formed. • A Delta based spread may contain any number of spread legs. CME SPAN® - Inter-Commodity Delta Based Spreading © 2010 CME Group. All rights reserved 18 • Another method of recognizing offsetting positions between Combined Commodities is Scanning Based Spreading. • Scanning Based Spreading recognizes risk offsets among Combined Commodities by scanning them together. • Scanning Based Spreading allows for the recognition of risk reduction due to correlated underlying price moves and also the risk reduction due to offsetting option positions. • In recognizing that the correlations between Combined Commodities may not be perfect, the gains in the Scanning process may be limited by a gain allowance factor set by the exchange. • The next two slides show an example of the potential benefits achieved through Scanning Based Spreading as opposed to Delta Based Spreading. Both slides use the same position of: Long 90 Bond futures Short 90 10yr futures CME SPAN® - Inter-Commodity Scanning Based Spreading © 2010 CME Group. All rights reserved 19 CME SPAN® - Delta Based Spread Example Spread Positions Product Position Outright PB Requirement Spread Ratio Spread Credit Bond 90 $2,500 2 70% 10 yr -90 $1,400 3 • Long 90 Bond futures & Short 90 10yr futures Spread Credit Product Position Outright PB Requirement Position x Outright PB Spread Credit Bond 60 $2,500 $150,000 $276,000 x .7 =$193,200 10 yr 90 $1,400 $126,000 Remaining Delta Product Position Outright PB Requirement Position x Outright PB Bond 30 $2,500 $75,000 10 yr 0 $0 $0 Delta-Based Total Requirement Remaining Delta PB Requirement Spread Req. (30%) Total PB Requirement $75,000 $82,800 $157,800 © 2010 CME Group. All rights reserved 20 CME SPAN® - Scanning Based Spread Example Scenario Underlying Price Move Volatility Change Gain/Loss 1 UNCHANGED UP $0 2 UNCHANGED DOWN $0 3 UP 33% UP -$10,449 4 UP 33% DOWN -$10,449 5 DOWN 33% UP $45,549 6 DOWN 33% DOWN $45,549 7 UP 67% UP -$21,051 8 UP 67% DOWN -$21,051 9 DOWN 67% UP $91,251 10 DOWN 67% DOWN $91,251 11 UP 100% UP -$31,500 12 UP 100% DOWN -$31,500 13 DOWN 100% UP $136,800 14 DOWN 100% DOWN $136,800 15 UP 300% UNCHANGED -$31,185 16 DOWN 300% UNCHANGED $135,432 Scanning Based PB Requirement $136,800 • Long 90 Bond futures & Short 90 10yr futures © 2010 CME Group. All rights reserved 21 • Deep out-of-the-money short options may show zero or minimal Scan Risk given the price & volatility moves in the 16 market scenarios. • However, in extreme events these options may move closer to-the- money or in-the-money, thereby generating potentially large losses. • To account for this potential exposure, a Short Option Minimum can be set for each product. • If the Scan Risk is lower than the Short Option Minimum, then the Short Option Minimum is charged. • The next slide shows an example of the Short Option Minimum using a deep out-of-the-money short put. Short 1 SP500 Sep 2010 Put @500 (underlying price is 1100) Short Option Minimum on 1 SP500 is $225 CME SPAN® - Short Option Minimum © 2010 CME Group. All rights reserved 22 CME SPAN® - Short Option Minimum Example Scenario Underlying Price Move Volatility Change Gain/Loss 1 UNCHANGED UP $16 2 UNCHANGED DOWN -$10 3 UP 33% UP $8 4 UP 33% DOWN -$10 5 DOWN 33% UP $27 6 DOWN 33% DOWN -$9 7 UP 67% UP $3 8 UP 67% DOWN -$11 9 DOWN 67% UP $41 10 DOWN 67% DOWN -$7 11 UP 100% UP -$1 12 UP 100% DOWN -$11 13 DOWN 100% UP $62 14 DOWN 100% DOWN -$4 15 UP 300% UNCHANGED -$4 16 DOWN 300% UNCHANGED $88 Scan Risk $88 • Scan Risk is $88, however SOM is $225, so the requirement is $225. © 2010 CME Group. All rights reserved 23 • Scan Risk: Evaluate the directional market risk. • Intra-Commodity Spread Charge: Evaluate the basis risk between contract periods with different expirations within the same product. • Inter-Commodity Spread Credit: Evaluate credit available for offsetting positions in related instruments. • Delivery Add-On Charge: Evaluate contract periods for increasing volatility during delivery. • Short Option Minimum: Evaluate short option positions for potential increased risk, using the greater of the Scan Risk or Short Option Minimum. • SPAN Requirement for a Combined Commodity is the greater of:  (Scan Risk + Intra Commodity Spread Charge + Delivery Charge – Inter Commodity Spread Credit) Short Option Minimum • The Total SPAN Requirement for a portfolio is the sum of the SPAN Requirement for all Combined Commodities. CME SPAN® - Summary of SPAN Analysis © 2010 CME Group. All rights reserved 24 • Mark-to-market of options is reflected in the Net Option Value component of SPAN. • The Total Performance Bond Requirement for a portfolio reflects the Total SPAN Requirement and the Net Option Value of the portfolio. • The Net Option Value (NOV) of a portfolio is equal to the Long Option Value minus the Short Option Value. • Long Option Value (LOV): The total value of all the long options in the portfolio. • Short Option Value (SOV): The total value of all the short options in the portfolio. • LOV reduces the overall Total Performance Bond Requirement. • SOV increases the overall Total Performance Bond Requirement. CME SPAN® - Net Option Value © 2010 CME Group. All rights reserved 25 • The portfolio below includes: Long 1 Sep 2010 SP Futures (price is 1100) Short 1 Sep 2010 SP 1000 Call Option (price is $119.10, value is $28,150) Long 1 Sep 2010 SP 900 Put Option (price is $3.20, option value is $162.50) CME SPAN® - Net Short Option Value SPAN Risk = $7,132 LOV = $162.50 SOV = $28,150 NOV = ($27,987.50) Total Requirement = SPAN Risk + NOV $7,132 - ($27,987.50) = $35,119.50 © 2010 CME Group. All rights reserved 26 • The portfolio below includes: Short 1 Sep 2010 SP Futures (price is 1100) Long 1 Sep 2010 SP 1000 Call Option (price is $119.50, value is $28,150) Short 1 Sep 2010 SP 900 Put Option (price is $3.20, option value is $162.50) CME SPAN® - Net Long Option Value SPAN Risk = $585 LOV = $28,150 SOV = $162.50 NOV = $27,987.50 Total Requirement = SPAN Risk + NOV $585 - $27,987.50 = ($27,402.50) CME SPAN® Slide Number 2 Slide Number 3 Slide Number 4 Scan Risk Arrays Slide Number 6 Slide Number 7 Slide Number 8 Slide Number 9 Slide Number 10 Slide Number 11 SPAN® Analysis Slide Number 13 Slide Number 14 Slide Number 15 Slide Number 16 Slide Number 17 Slide Number 18 Slide Number 19 Slide Number 20 Slide Number 21 Slide Number 22 Slide Number 23 Slide Number 24 Slide Number 25 Slide Number 26
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