Varied of today’s stock option traders may not realize that margin wear the crowns differ across the various option exchanges. For instance, the Chicago Surface Options Exchange (CBOE) has a margin system different from that worn by the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME). The latter two use a combination known as standardized portfolio analysis of risk, or SPAN, the world’s greatest margin system, adopted by most options and futures exchanges round the world. It is based on a sophisticated set of algorithms that determine margin according to a worldwide (total portfolio) assessment of the one-day risk of a trader’s account.
Let’s look at the unspecific idea behind margin and what SPAN futures and option scope are. SPAN provides futures and commodity option strategists with a key benefit: more bang for their margin buck. (See also: Investopedia Academy’s Opportunities for Beginners.)
What Is Option Margin?
Option margin, very unmistakably, is the money that a trader must deposit into his or her trading account in well-organized to trade options. This is not the same as margining stock. Margin for arrays is actually a loan to you from your broker so that you can buy more capital with less available capital. Margin for options on futures is a show bond deposit that earns interest because it is usually influenced in the form of short-term Treasury bills.
For example, to write a simple sustain call spread on the S&P 500, you would need to have sufficient border (a “good-faith” performance bond) in your account to open the position. Acquiring options outright typically does not require any deposit of margin because the extremity risk is what you pay for the option.
For our purposes, margin is what the broker forces you to have in your account if you want to implement an option writing blueprint. For a typical “one-lot” (i.e., a simple 1 x 1) credit-spread position, margin—depending on the deal in involved—can range from as low as a few hundred dollars (on grains like soybeans, for pattern) to as much as several thousand dollars (on the S&P 500, for instance). A good hand down a judgement of thumb is that the ratio of margin to net premium collected should be 2-to-1. That is, you should try to understand option trades that give you a net premium that is at least one-half the sign margin costs.
One additional point about option margin is that it is not firm. In other words, initial margin is the amount required to open a placing, but that amount changes every day with the market. It can go up or down depending on mutations in the underlying asset, time to expiration and levels of volatility. SPAN verge, which is the margin system developed by the Chicago Mercantile Exchange and reach-me-down by all traders of options on futures, can help explain how this movement moves. SPAN margin is considered by many to be the superior margin system present.
The SPAN System
For option writers, SPAN margin requirements for to be to comes options offer a more logical and advantageous system than ones old by equity option exchanges. It is, however, important to point out that not all brokerage lines give their customers SPAN minimum margins. If you are serious close by trading options on futures, you must seek out a broker who will furnish you with SPAN minimums. The beauty of SPAN is that after scheming the worst-case daily move for one particular open position, it applies any plethora margin value to other positions (new or existing) requiring margin.
Time to comes exchanges predetermine the amount of margin required for trading a futures compress, which is based on daily limit prices set by the exchanges. The predetermined amount of verge required allows the exchange to know what a “worst-case” one-day on ones way might be for any open futures position (long or short).
Risk breakdown is also done for up and down changes in volatility, and these risks are based into what are known as risk arrays. Based on these variables, a peril array is created for each futures option strike price and approaches contract. A worst-case risk array for a short call, for example, determination be futures limit (extreme move up) and volatility up. Obviously, a short discontinue will suffer from losses from an extreme (limit) stir up up of the underlying futures and a rise in volatility. SPAN margin requirements are persevering by a calculation of possible of losses. The uniqueness of SPAN is that, when authenticating margin requirements, it takes into account the entire portfolio, not by a hairs breadth the last trade.
The Key Advantage of SPAN
The margining system used by the comings options exchanges provides a special advantage of allowing Treasury charges to be margined. Interest is earned on your performance bond (if in a T-bill) because the stock markets view Treasury bills as marginable instruments. These T-bills, nevertheless, do get a “haircut” (a $25,000 T-bill is marginable to the value between $23,750 and $22,500, depending on the unambiguous house). Because of their liquidity and near-zero risk, T-bills are angled as near-cash equivalents. Because of this margining capacity of T-bills, quicken earnings can sometimes be quite sizable, which can pay for all or at least offset some of the negotiation costs incurred during trading—a nice bonus for option journoes.
SPAN itself offers one key advantage for option traders who combine assembles and puts in writing strategies. Net option sellers can often receive favorable treatment. Here’s an benchmark of how you can acquire an edge. If you write a one-lot S&P 500 call credit spread, which has the within easy reach leg at about 15% out of the money with three months until expiry, you see fit get charged approximately $3,000-$4,000 in initial SPAN margin demands. SPAN assesses total portfolio risk, so, when and if you add a put credit spread with an offsetting delta fact (i.e., the call spread is net short 0.06 and the put spread is net long 0.06), you roughly are not charged more margin if the overall risk is not increased according to Extent risk arrays.
Since SPAN is logically looking at the next day’s worst-case directional on the go, one side’s losses are largely offset by the other side’s gains. It is in no way a perfect hedge, however, because rising volatility during an ultimate limit move of the futures could hurt both sides, and a non-neutral gamma when one pleases change the delta factors. Nevertheless, the SPAN system basically does not dual charge you for initial margin on this type of trade, which is remembered as a covered short strangle because one side’s risk is mostly quashed by the other side’s gains. This basically doubles your limits power. An equity or index option trader does not get this favorable treatment when working with the same strategy.
The Bottom Line
While there are other classifications of trades that would illustrate the advantages of SPAN, the covered transitory strangle example shows why index and equity option writers be left at a competitive disadvantage. (See also: An Option Strategy for Trading Market Bottoms.)