SPAN Margin

SPAN Margin - Definition

SPAN Margin is a system of determining margin requirements for futures trading which uses one-day risk assessment rather than a fixed percentage.

SPAN Margin - Introduction

SPAN, Standardized Portfolio Analysis of Risk, is a new and more intelligent way of determining margin requirements for futures trading which is quickly adopted in many futures markets all over the world. Before the invention of SPAN margin, initial margin for putting on a futures position is based on an arbitrary fixed percentage determined by each individual market. The problem with such a fixed percentage is that it is normally unnecessarily high due to the need to reduce risk. SPAN margin generally lowers initial margin requirements to a more intelligent and calculated level, resulting in a more liquid futures market without increasing risk.

This tutorial shall explore in depth what SPAN Margin is, its working mechanism as well as a brief history of how it came about.

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What Exactly Is SPAN Margin?

SPAN Margin is an innovation by the CME (same organisation that gave us the CME Nikkei225 Futures) back in 1988. Before the onset of SPAN Margin, initial margin requirement in futures trading is determined largely by regulations or by the exchanges themselves and the bad thing about not having SPAN margin is that all futures trades are based on a fixed percentage initial margin without regard to the potential risk level of the trade. As such, Futures Spreads, which actually limit risk end up paying initial margin for each leg of the spread, thereby greatly increasing initial margin and punishing the sophisticated futures trader who is using spreads to limit risk.

Unlike the traditional method, SPAN margin is a totally risk based method of determining futures margin requirements. It calculates margin requirement based on a sophisticated mathematical model which is based on the worst case one-day scenario of a trade. This has the potential of determining a more realistic initial margin than the traditional method can. However, the most important thing about this risk based approach of SPAN Margin is really in the area of Futures Spreads. Since Futures Spreads actually limits risk, SPAN margin takes this into consideration and typically requires an initial margin which is LESSER than you would if you had not used a spread! That's right! Instead of paying two initial margins for a two legged bull spread under the traditional model, you would probably pay lesser than a single initial margin of an outright futures position under SPAN margin! This rewards futures traders for being more sophisticated and for taking on risk limited approaches to futures trading, resulting in a safer and more liquid futures market.

To date, SPAN Margin is applied also to intercommodity spreads, spreads between different underlying assets, allowing a single initial margin for such spreads instead of having to pay two different initial margins for each futures contract of each underlying asset. This is truly a great leap forward that made intercommodity spreads much more capital efficient. SPAN Margin is also capable of calculating risk in a Futures and Futures-Options position, making margin requirements in such risk limited combinations more reasonable.

Almost all futures chains quoted based on SPAN margin will indicate the wordings "SPAN" or "SPAN Margin" somewhere. SPAN Margin has been expanded to also include margin calculations for Options Trading as well.

How Does SPAN Margin Work?

Without being too technical, SPAN Margin work by calculating the worst possible loss in a single day period by coming up with a set of 16 different gains and losses outcomes under various market conditions. This is known as a "Risk Array". The system then selects the "Largest Reasonable Loss" amongst these 16 different scenarios and uses that amount as SPAN Margin requirement.

SPAN Margin Parameters

SPAN Margin system takes into consideration 6 parameters in coming up with the "Risk Array", which is the heart of the SPAN Margin process. These parameters are adjustable by each exchange and clearinghouse in order to better adjust the SPAN margin system to their risk appetite.

Price Scan Range : This is the parameter that decides how deep a loss the Risk Array go into when computing SPAN Margin requirement. It is a set range of maximum possible price movement.

Volatility Scan Range : Applicable for options SPAN Margin. It is a set of expected implied volatility changes which can significantly affect an option's price.

Intracommodity Spread Charge : Basis risk of calendar spreads.

Intercommodity Spread Charge : Risk of offsetting positions between related underlyings.

Spot Risk : Risk of delivery of underlying asset as expiration day draws near.

Short Option Minimum : Another options SPAN Margin parameter which governs the minimum margin requirement for short options positions.

SPAN Margin Products

CME (Chicago Mercantile Exchange) has developed what is known as the SPAN Product Suite, which is a set of software catering to varying levels of portfolio risk analysis needs:

PC-SPAN : Single PC application for personal use calculating SPAN Margin across multiple exchanges.

SPAN Risk Manager : Enhancement of the PC-SPAN to include a full suite of risk analysis tools mainly for professional use.

SPAN Risk Manager Clearing : Institutional level application allowing exchanges and clearinghouses to implement SPAN Margin quickly and efficiently.

Advantages of SPAN Margin

:: Able to establish margin requirement for outright futures trading positions in a more reasonable manner.

:: Integrates margin requirements for futures spreads into a lower single margin requirement.

:: Makes possible a single and lower margin requirement for intercommodity spreads and futures/options combinations.

:: SPAN Margin lowers margin requirement thereby increasing your ROI.

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