By settling with clearing members on a daily basis the clearing house
restricts the level of risk itself and the other market members are
exposed to.
Options on futures positions are margined in the same way as
futures contracts with initial and VM requirements.
Long premium paid or traded option positions are not charged ini-
tial margin because once the premium has been paid for the option,
on T 1, then there is no further risk to the clearing house. The
worst that can happen is that the option can expire at zero.
If a long option is exercised then the clearing house will call margin
to cover the delivery obligations.
Short option positions are margined, as there is a risk of the writer
being unable financially to fulfil their delivery obligations. This mar-
gin requirement is typically calculated using SPAN or a similar
exchange margin method such as TIMS. Detailed explanation of both
SPAN and TIMS is given in the appendices.
Most clearing houses pay interest to members on cash deposited to
cover their initial margin requirements. At LCH.Clearnet interest is
paid on cash balances using rates that are actually set by the clear-
ing house. These rates are known as the London Deposit Rates (LDR)
and they are derived from bid rates for overnight funds quoted by
selected money brokers and major banks for each currency. The
highest and lowest rates are discounted to calculate the average.
Many brokerage houses use the LDR rates plus 1 per cent or minus
1
/
2
per cent as a basis of rates charged or paid to their clients.
An explanation of delta
When it comes to margin calculation the process is sometimes very
straightforward and sometimes more complex. For example, a futures
position can be margined on a rate-per-contract basis whilst option
positions, because they have strike prices and Calls and Puts, present
more of a challenge in determining a fair but realistic margin rate. The
price of different option series can move at different rates and by dif-
ferent values. One measure of the amount that an option series should
change by a given change to the underlying is called delta.
The delta of an option can be described as the amount by which an
option’s premium moves, with respect to the changes in the underly-
ing security price. Gamma measures the speed of change and as time
value, the theta, decreases, this also affects the price or value of an
option. A deep in-the-money option has a delta of 1, a far out-of-the-
money option a delta of 0 and an at-the-money option a delta of 0.5.
126 Clearing and settlement of derivatives
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