Equity-Style Option Margin Examples
November 15, 2006
© Copyright Intercontinental Exchange, Inc. 2006. All Rights Reserved.
www.theice.com
Table of Contents
1.
OVERVIEW................................................................................................................................................. 3
2.
SUMMARY .................................................................................................................................................. 3
3.
FUTURES-STYLE OPTIONS ................................................................................................................... 4
3.1.
3.1.1.
In-the-money bought option ............................................................................ 5
3.1.2.
Out-of-the-money bought option...................................................................... 6
3.1.3.
In-the-money sold option ................................................................................. 7
3.1.4.
Out-of-the money sold option .......................................................................... 8
3.2.
4.
LIMIT CASES ......................................................................................................................................... 5
EXAMPLE PORTFOLIO ........................................................................................................................... 9
EQUITY-STYLE OPTIONS .................................................................................................................... 10
4.1.
LIMIT CASES ....................................................................................................................................... 11
4.1.1.
In-the-money bought option .......................................................................... 11
4.1.2.
Out-of-the-money bought option.................................................................... 12
4.1.3.
In-the-money sold option ............................................................................... 13
4.1.4.
Out-of-the money sold option ........................................................................ 14
4.2.
EXAMPLE PORTFOLIO ......................................................................................................................... 15
ICE Futures – Equity-style option margin examples
Page 2
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Equity-Style Option Margin Examples
1. Overview
This document contains worked examples comparing the effect on overall initial margin
figures of ‘equity-style’ option premium payment and margin calculation with the traditional
‘futures-style’ method. ICE currently list Penultimate Henry Hub Natural Gas OTC cleared
options as equity-style contracts, and ICE Futures are intending to launch a WTI Crude
Option contract which will also be an equity-style contract.
This document is intended for traders and back office staff who wish to understand how their
initial margin requirements will be influenced by the new-style contracts.
No understanding of the mechanics of SPAN margining is required.
2. Summary
The premium on futures-style options is paid on expiry, and has no influence on the margin
requirements for the trader’s portfolio during the options lifetime.
Using equity-style options where the premium is paid ‘up-front’ allows LCH.Clearnet
(“LCH.C”) to utilize the intrinsic value of the option, and effectively allow the buyer of an
option to gain advantage from having paid the premium by using its value to significantly
reduce their overall initial margin requirements.
Examples are given in more detail in the following sections, but an idea of the potential
benefits for holders of long option positions can be gained from the following summary of
sections 3.2 and 4.2 :
Portfolio
Full initial
margin ($)
Net Liquidation
Value of option ($)
Total initial margin
requirement ($)
Futures +
‘futures-style’
option
381557.00
N/A
381557.00
Futures +
‘equity-style’
option
381557.00
143625.00
237932.00
The example yields an approximate decrease in initial margin requirements of 38% when
comparing futures-style to equity-style options in otherwise identical portfolios.
Conversely, sellers of equity-style options must provide collateral or hold bought option
positions to cover the fact that their short options have a negative value, effectively adding to
the overall margin requirement.
ICE Futures – Equity-style option margin examples
Page 3
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3. Futures-style options
Futures-style option contracts have the premium paid/received at option expiry time. In this
case, the premium ‘value’ has no influence on the treatment of the total portfolio initial
margin calculation.
In this case, options are effectively margined as if they were the delta-equivalent futures
position (100 lot bought option at Δ 0.7 = 70 lot bought future position). Initial margins are
calculated for both long and short option positions to reflect the cost of closing out positions
in case of default.
The examples below use the superseded futures-style Penultimate Henry Hub (PHH)
options. The examples go through several extreme limit cases involving single uncovered
long or short option positions, followed by an example using a basic portfolio including other
positions.
ICE Futures – Equity-style option margin examples
Page 4
3.1.
Limit cases
3.1.1. In-the-money bought option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHH
Buy
Call
JAN07
3.000
10
5.540
Margined as a bought future.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC1
MARGIN
GROUP
INITIAL
NET
CONTINGENT
DISCOUNTED
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-24200
0.000
0.000
0.000
-24200.000
IPE
USD
Account Totals:
---------------USD
-24200.000
----------------
www.theice.com
3.1.2. Out-of-the-money bought option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHH
Buy
Call
JAN07
15.000
10
0.020
Margined as a bought future.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC2
MARGIN
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-450
0.000
0.000
0.000
-450.000
GROUP
IPE
USD
Account Totals:
---------------USD
-450.000
----------------
ICE Futures – Equity-style option margin examples
Page 6
www.theice.com
3.1.3. In-the-money sold option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHH
Sell
Call
JAN07
3.000
10
5.540
Margined as a sold future.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC3
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-25000
0.000
0.000
0.000
-25000.000
MARGIN
GROUP
IPE
USD
Account Totals:
---------------USD
-25000.000
----------------
ICE Futures – Equity-style option margin examples
Page 7
www.theice.com
3.1.4. Out-of-the money sold option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHH
Sell
Call
JAN07
15.000
10
0.020
Margined as a sold future.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC4
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-3050
0.000
0.000
0.000
-3050.000
MARGIN
GROUP
IPE
USD
Account Totals:
---------------USD
-3050.000
----------------
ICE Futures – Equity-style option margin examples
Page 8
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3.2.
Example portfolio
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
B
Buy
Future
DEC07
30
G
Sell
Future
MAR07
15
T
Buy
Future
JAN07
50
PHH
Buy
Call
JAN07
7.800
Lots
50
Closing futures price
1.150
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC9
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-381557
0.000
0.000
0.000
-381557.000
MARGIN
GROUP
IPE
USD
Account Totals:
---------------USD
-381557.000
----------------
ICE Futures – Equity-style option margin examples
Page 9
4. Equity-style options
The premium on Equity-style option contracts is paid/received at trade time. LCH.Clearnet
then regard the contract as having a Net Liquidation Value (positive for option buyers,
negative for sellers), which – if positive - is offset-able against the total portfolio initial
requirement. If negative, it must be covered by collateral or by positive Net Liquidation Value
(“NLV”) from long option positions.
The basic initial margin calculation is still performed for both bought and sold option
positions, but for bought options the initial margin requirement is always covered by the
positive NLV resulting from the option.
For bought options, the initial margin charged will never exceed the Net Liquidation
Value of the option.
The
examples
below
use
equity-style
Penultimate
Henry
Hub
(PHE)
options.
4.1.
Limit cases
4.1.1. In-the-money bought option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHE
Buy
Call
JAN07
3.000
10
5.538
Margined as a bought future, margin requirement is offset by NLV. As option is in-the-money there is excess positive NLV available to offset
other margin requirements.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC5
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-24200
138450.000
0.000
0.000
114250.000
MARGIN
GROUP
IPE
USD
Account Totals:
---------------USD
0.000
----------------
www.theice.com
4.1.2. Out-of-the-money bought option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHE
Buy
Call
JAN07
15.000
10
0.020
Margined as a bought future. The further out-of-the money an option gets, the more the margin requirement tends toward (but will never exceed)
the NLV. In this case the margin requirement is completely covered by the positive NLV, but none is ‘spare’ to offset other margins.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC6
MARGIN
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-450
450.000
0.000
0.000
0.000
GROUP
IPE
USD
Account Totals:
---------------USD
0.000
----------------
ICE Futures – Equity-style option margin examples
Page 12
www.theice.com
4.1.3. In-the-money sold option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHE
Sell
Call
JAN07
3.000
10
5.540
Margined as a sold future. Note that for a sold option, the Net Liquidation Value is negative, and must be covered either by collateral or by
positive NLV on bought option positions.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC7
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-25000
-138450.000
0.000
0.000
-163450.000
MARGIN
GROUP
IPE
USD
Account Totals:
---------------USD
-163450.000
----------------
ICE Futures – Equity-style option margin examples
Page 13
www.theice.com
4.1.4. Out-of-the money sold option
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
Lots
Closing futures price
PHE
Sell
Call
JAN07
15.000
10
0.020
Margined as a sold future.
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC8
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-3050
-450.000
0.000
0.000
-3500.000
MARGIN
GROUP
IPE
USD
Account Totals:
---------------USD
-3500.000
----------------
ICE Futures – Equity-style option margin examples
Page 14
www.theice.com
4.2.
Example portfolio
Commodity
Buy/Sell
Call/put/future
Expiry
Strike
B
Buy
Future
DEC07
30
G
Sell
Future
MAR07
15
T
Buy
Future
JAN07
50
PHE
Buy
Call
JAN07
7.800
Lots
50
Closing futures price
1.150
LCH SPAN Ver 4.0
THE LONDON CLEARING HOUSE LIMITED
DATE: 15 NOV 2006
RPT NMG
Net Margin Report by Margin Group
PAGE: 1
ACCOUNT: ICEACC10
MARGIN
NET
CONTINGENT
DISCOUNTED
INITIAL
LIQUIDATION
VARIATION
VARIATION
NET
CURRENCY
MARGIN
VALUE
MARGIN
MARGIN
MARGIN
-------- --------
----------------
----------------
----------------
----------------
----------------
-381557
143625.000
0.000
0.000
-237932.000
GROUP
IPE
USD
Account Totals:
---------------USD
-237932.000
----------------
ICE Futures – Equity-style option margin examples
Page 15