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THE objective of SPAN is to identify overall risk in a portfolio of futures and options contracts for each member.

The system treats futures and options contracts uniformly, while at the same time recognising the unique exposures associated with options portfolios such as extremely deep out-of-the-money short positions, inter-month risk and inter-commodity risk.

In standard pricing models, three factors most directly affect the value of an option at a given point in time: * Underlying market price * Volatility (variability) of underlying instrument * Time to expiration

As these factors change, so too will the value of futures and options maintained within a portfolio. SPAN constructs scenarios of probable changes in underlying prices and volatilities in order to identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin requirement at a level sufficient to cover this one-day loss.

Calendar Spread: As SPAN scans futures prices within a single underlying instrument, it assumes that price moves correlate perfectly across contract months. Since price moves across contract months do not generally exhibit perfect correlation, SPAN adds a Calendar Spread Charge (also called the Inter-month Spread Charge) to the Scanning Risk Charge associated with each futures and options contract.

To put it in a different way, the Calendar Spread Charge covers the calendar (inter-month etc.) basis risk that may exist for portfolios containing futures and options with different expirations. For each futures and options contract, SPAN identifies the delta associated each futures and option position, for a contract month. It then forms spreads using these deltas across contract months. For each spread formed, SPAN assesses a specific charge per spread which constitutes the Calendar Spread Charge.

The margin for calendar spread shall be calculated on the basis of delta of the portfolio in each month. Thus a portfolio consisting of a near-month option with a delta of 100 and a far-month option with a delta of - 100 would bear a spread charge equivalent to the calendar spread charge for a portfolio which is long 100 near-month futures contract and short 100 far-month futures contract. A calendar spread would be treated as a naked position in the far-month contract three trading days before the near-month contract expires.

Short Option Minimum Charge: Short options positions in extremely deep-out-of-the-money strikes may appear to have little or no risk across the entire scanning range. However, in the event that underlying market conditions change sufficiently, these options may move into-the-money, thereby generating large losses for the short positions in these options. To cover the risks associated with deep-out-of-the-money short options positions, SPAN assesses a minimum margin for each short option position in the portfolio called the Short Option Minimum charge, which is set by the NSCCL. The Short Option Minimum charge serves as a minimum charge towards margin requirements for each short position in an option contract.

For example, suppose that the Short Option Minimum charge is Rs 50 per short position. A portfolio containing 20 short options will have a margin requirement of at least Rs 1,000, even if the scanning risk charge plus the inter-month spread charge on the position is only Rs 500.

Net Buy Premium: In the above scenario only sell positions are margined and offsetting benefits for buy positions are given to the extent of long positions in the portfolio by computing the net option value. To cover the one-day risk on long option positions (for which premium shall be payable on T+1 day), net buy premium to the extent of the net long options position value is deducted from the Liquid Networth of the member on a real time basis.

This would be applicable only for trades done on a given day. The Net Buy Premium margin shall be released towards the Liquid Networth of the member on T+1 day after the completion of pay-in towards premium settlement. Computation of Initial Margin - Overall Portfolio Margin Requirement

The total margin requirements for a member for a portfolio of futures and options contract would be computed as follows: * SPAN will add up the Scanning Risk Charges and the Intracommodity Spread Charges. * SPAN will compares this figure to the Short Option Minimum charge* It will select the larger of the two values.

* Total SPAN Margin requirement is equal to SPAN Risk Requirement, less the `net option value', which is mark to market value of difference in long option positions and short option positions. * Initial Margin requirement = Total SPAN Margin Requirement + Net Buy PremiumRate of interest may be the relevant MIBOR rate or such other rate as may be specified.concluded

SPAN is a registered trademark of the Chicago Mercantile Exchange, used herein under License. The Chicago Mercantile Exchange assumes no liability in connection with the use of SPAN by any person or entity.

Source: www.nseindia.com

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