LME Clear uses Standard Portfolio Analysis of Risk (SPAN*) to calculate initial margin.
*SPAN is a registered trademark of Chicago Mercantile Exchange Inc., used herein under licence. Chicago Mercantile Exchange Inc. assumes no liability in connection with the use of SPAN by any person or entity.
SPAN considers how the value of an entire portfolio of options and futures will respond to changes in futures (or underlying) prices and volatilities. SPAN simulates potential market moves and calculates the profit or loss on individual contracts. LME Clear uses OIS rather than LIBOR interest rates when calculating discounting forward cash-flows. Margin rates will be calculated using a 2 day liquidation period (EMIR minimum).
Margin rates and volatility shifts are currently being calculated at 99% and 99.5% single tailed confidence intervals utilising the worst case of a two year and ten year price history.
Parameters will be calculated daily, but usually updated monthly, and set in SPAN as an absolute figure.
Initial margin calculation
SPAN utilises the margin parameters to calculate the initial margin. SPAN splits the initial margin calculation into four components;
- Scanning risk - The scanning risk is a worst-case portfolio loss based on the net position. Scanning ranges, volatility shifts and inter-currency shifts are all part of the scanning risk calculation.
- Inter-prompt spread - SPAN scanning risk assumes that forward prices move by identical amounts across all prompt dates. The inter-prompt spread utilises the inter-prompt spread charge to calculate the margin requirement to cover the differences in price moves between prompt dates.
- Inter-contract credit - SPAN provides a credit to recognise cases where offsetting positions in related contracts reduce overall portfolio risk. This is calculated using the inter-contract spread credit.
- Short option minimum charge - This covers the cost of closing out deeply out-of-the-money options which have very small intrinsic value. It therefore calculates a floor to the margin requirement for short option positions.
In its role as a risk manager, LME Clear may have cause to call additional margin on occasion where certain characteristics of the portfolio or clearing member dictate that the initial margin is deemed insufficient to protect LME Clear from the risk posed.
Additional margin can be taken in four main forms which are:
- concentration margin
- default additional margin
- additional credit margin
- discretionary margin
Login or register to view the detailed service specification for further information on additional margins.
In addition to a full range of risk factor backtesting, LME Clear performs portfolio backtesting on historical, hypothetical and representative member portfolios.
Full description of the methodology, as well as the latest results (PDF)