What Is SPAN Margin?
SPAN margin is calculated by standardized portfolio analysis of risk (SPAN), a leading system that has been adopted by many options and futures exchanges around the world.
SPAN is based on a sophisticated set of algorithms that determine margin requirements according to a global (total portfolio) assessment of the one-day risk for a trader's account.
- SPAN Margin determines margin requirements based on a global assessment of the one-day risk for a trader's account.
- SPAN margins are calculated using risk arrays and modeled risk scenarios that are processed and analyzed by sophisticated algorithms.
- Many, but not all, of today's major derivatives exchanges utilize SPAN.
Understanding SPAN Margin
Option margin refers to the money that a trader must deposit into a trading account in order to trade options. This is not the same as margining stock. Margin for stocks is actually a loan to you from your broker so that you can buy more stock with less available capital. Margin for options on futures is a performance bond deposit that earns interest because it is usually held in the form of short-term Treasury bills.
Options and futures writers are required to have a sufficient amount of margin in their accounts to cover potential losses. The SPAN system, through its algorithms, sets the margin of each position in a portfolio of derivatives and physical instruments to its calculated worst possible one-day move. It is calculated using a risk array that determines the gains or losses for each contract under different conditions. These conditions are referred to as risk scenarios and measure profits (or losses) with respect to price change, volatility change, and decrease in time to expiration.
The main inputs to the models are strike prices, risk-free interest rates, changes in prices of the underlying securities, changes in volatility, and decreases in time to expiration. The system, after calculating the margin of each position, can shift any excess margin on existing positions to new positions or existing positions that are short of margin.
Traders may not realize that margin rules differ across the various options exchanges. For instance, the Chicago Board Options Exchange (CBOE) has a margin system different from that used by the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME). The latter two use the SPAN system.
The SPAN System
For options writers, SPAN margin requirements for futures options offer a more logical and advantageous system than ones used by equity options exchanges. It is, however, important to point out that not all brokerage houses give their customers SPAN minimum margins. If you are serious about trading options on futures, you must seek out a broker who will provide you with SPAN minimums. The beauty of SPAN is that after calculating the worst-case daily move for one particular open position, it applies any excess margin value to other positions (new or existing) requiring margin.
Futures exchanges predetermine the amount of margin required for trading a futures contract, which is based on daily limit prices set by the exchanges. The predetermined amount of margin required allows the exchange to know what a "worst-case" one-day move might be for any open futures position (long or short).
Risk analysis is also done for up and down changes in volatility, and these risks are built into what are known as risk arrays. Based on these variables, a risk array is created for each futures option strike price and futures contract. A worst-case risk array for a short call, for example, would be futures limit (extreme move up) and volatility up. Obviously, a short call will suffer from losses from an extreme (limit) move up of the underlying futures and a rise in volatility. SPAN margin requirements are determined by a calculation of possible losses. The uniqueness of SPAN is that, when establishing margin requirements, it takes into account the entire portfolio, not just the last trade.
Advantage of SPAN
The margining system used by the futures options exchanges provides a special advantage of allowing Treasury bills to be margined. Interest is earned on your performance bond (if in a T-bill) because the exchanges view Treasury bills as marginable instruments. These T-bills, however, do get a "haircut" (a $25,000 T-bill is marginable to the value between $23,750 and $22,500, depending on the clearinghouse). Because of their liquidity and near-zero risk, T-bills are viewed as near-cash equivalents. Because of this margining capacity of T-bills, interest earnings can sometimes be quite sizable, which can pay for all or at least offset some of the transaction costs incurred during trading—a nice bonus for options writers.
SPAN itself offers one key advantage for options traders who combine calls and puts in writing strategies. Net options sellers can often receive favorable treatment. Here's an example of how you can acquire an edge. If you write a one-lot S&P 500 call credit spread, which has the near leg at about 15% out of the money with three months until expiry, you will get charged approximately $3,000-$4,000 in initial SPAN margin requirements. SPAN assesses total portfolio risk, so, when and if you add a put credit spread with an offsetting delta factor (i.e., the call spread is net short 0.06 and the put spread is net long 0.06), you generally are not charged more margin if the overall risk is not increased according to SPAN risk arrays.
Since SPAN is logically looking at the next day's worst-case directional move, one side's losses are largely offset by the other side's gains. It is never a perfect hedge, however, because rising volatility during an extreme limit move of the futures could hurt both sides, and a non-neutral gamma will change the delta factors. Nevertheless, the SPAN system basically does not double charge you for initial margin on this type of trade, which is known as a covered short strangle because one side's risk is mostly canceled by the other side's gains. This basically doubles your margin power. An equity or index options trader does not get this favorable treatment when operating with the same strategy.