MAOF Clearing House Margin Requirements
Option buyers and sellers and futures buyers are exposed to the risk that counterparty will not meet its obligations on the expiration date. To prevent such a situation from occurring, a central counterparty (CCP) was established to take upon itself the risk of default, and by doing so, it practically becomes a party to the transaction.
For example, if investor A buys an option (long position) sold by investor B (short position), the central counter party takes investor B’s obligation towards investor A upon itself. Should investor B default on its obligation, investor A will receive the money amount, which he is entitled to receive from the central counterparty.
The Derivatives (MAOF) Clearing House serves as central counterparty for traded TASE derivatives. The MAOF Clearing House demands margin requirements from its members in order to secure its stability in the event of a member's defaults. The margin required is designed to reflect the value of a member’s obligations over a broad spectrum of possible scenarios that may occur prior to expiration.
MAOF Clearing House members
also demand margin requirements from its customers.
The MABAT online margin system calculates the margin requirements for each MAOF Clearing House member on a continual basis in real time throughout the trading day.
The MAOF Clearing House uses an array scenario methodology to calculate the margin requirements placed on its members. The risk array is based on the Standard Portfolio Analysis of Risk (SPAN) methodology developed in 1988 by the Chicago Mercantile Exchange (CME), one of the leading derivatives exchanges worldwide.
This methodology is employed on many exchanges worldwide. Under SPAN, customer portfolios are valuated using option pricing model to assess asset value against an array of possible market scenarios.
Through the risk array, the maximum cost that may be required to close positions in a portfolio containing options and futures is estimated. The margin required at any given point of time is contingent of the price of the underlying asset, market volatility (standard deviation), the interest rate and time-to-expiry.
The risk array used for TASE’s derivatives market incorporates 45 possible “market” scenarios, which could result from fluctuations in underlying asset (the TA-35 index, NIS/dollar exchange rate, etc.) prices and in their respective standard deviations.
For 44 of these scenarios, the theoretical value of a customer’s portfolio is calculated using the Black & Scholes (B&S) option pricing model, while for the 45th scenario the value of the customer’s portfolio is based on the latest market prices of the options. The margin required to secure futures contracts is calculated by breaking the contract into two options, 'put' and 'call' with the same exercise price, equal to the settlement price indicated in the futures contract. A customer is requested to place margin by the worst scenario assuming a maximum expected cost to close positions.
The risk array system serves the MAOF Clearing House on a daily basis to set margin requirements for each MAOF Clearing House member. These requirements are set according to the scenario embodying the highest financial risk for each member. Margin requirements are calculated by the MABAT, a real-time margin control system that calculates margin requirements throughout the entire trading day.
The risk array system also serves TASE members in setting margin requirements for its customers.
At first, the Price scan range is set for each underlying asset in percent. For each underlying asset, the maximum percentage fluctuation is determined based on a VaR (Value at Risk) mechanism at a confidence level of 99.5% at various time horizons of up to 5.35 years (reflecting the business cycle in the Israeli economy) and reflecting a three-day liquidity period. The maximum fluctuation in all the underlying assets is examined at least once a month and, if necessary, is updated according to the updated calculation result. If we designate the price scan range by the letter “m” and the last posted spot price as "S0", the risk array will be as follows:
Maximum Rate -
9 Intermediate Scenariosup side -
Current Rate -
9 Intermediate Scenariosdown side -
Minimum Rate - S0(1-m)
Each one of these 21 scenarios are examined for two distinct market volatility (standard deviation) levels, creating 42 scenarios. The volatility levels are calculated around the standard deviation of the underlying asset observed in the market at the time the risk array is calculated. The standard deviations used in the risk array equals the standard deviation observed in the market with the addition or subtraction of one fifth of the standard deviation value. For example, if the standard deviation of the TA-35 index is 25%, the standard deviations used in the risk array will be 20% and 30%, respectively. The addition or subtraction must exceed a minimal rate, which varies with each underlying asset. For example, for the TA-35 index, the minimum rate is currently set as 4%.
Three additional scenarios have been added to the 42 scenarios above – two “extreme-case” scenarios and a “market value” scenario.
extreme-case scenarios are designed to address “deep-out-of-the-money” options. For these scenarios, the price scan range and the volatility scan range are doubled. For example, if the price scan range for the TA-35 index is set at 12%, for the two extreme-case scenarios it will be 24% in each direction. The results are multiplied by 35%.
- In the
market value scenario, the value of the customer’s portfolio is calculated according to the last options market prices (in the first day of trading an option or in the event there was no trade in a option during the previous day, the market price will be calculated according to the theoretical value). This scenario is meant to ensure that the collateral required from the customer in situations in which options are priced in the market according to standard deviations, which differ significantly from those used to generate the risk array.
Derivatives (MAOF) Clearing House Member Margin Requirements under the Risk Array
The margin required from a member of the MAOF Clearing House equals the sum of the margin required from all its customers according to the scenario which renders the highest margin requirement. The margin requirements stemming from Nostro account (an account where the member invests for himself) are added.
The following example will illustrate this. For simplicity’s sake, assume three scenarios and three customers. The following table presents the value of customer portfolios under each scenario:
For each member in each scenario, all customer portfolios bearing negative values are summed up. Only customers required to deposit collateral are taken into account. In other words, the MAOF Clearing House member is not entitled to offset customer portfolios that are required to deposit margin against portfolios which are not. The margin requirement will equal the lowest sum received from all the scenarios (“worst-case scenario”). In the above example, the margin requirement will equal 30 plus the margin requirement placed on the member’s Nostro account, which in this case is 10. The total margin requirement is, therefore, 40.
It should be noted that this calculation is made separately for each underlying asset (derivatives on the TA-35 index, NIS/dollar exchange rate, NIS/Euro exchange rate, etc.). The margin requirements for each underlying asset are then added up to obtain the total margin requirement placed on the MAOF Clearing House member.
The risk array also serves TASE members in determining margin requirements for its customers. However, the margin required by TASE members from its clients may vary according to the type of customer.
Collateral Deposits Required of Derivatives (MAOF) Clearing House Members
The MAOF Clearing House allows its members to deposit collateral to cover margin requirements in two ways:
TASE Clearing House Account – Members are entitled to deposit MAKAM (T-Bills) and Israel government bonds in an account at the TASE Clearing House, which is pledged in favor of the MAOF Clearing House.
Bank of Israel Account – Members are allowed to deposit cash only in this bank account, the money deposited is pledged in favor of the MAOF Clearing House.
The online margin system (MABAT) calculates MAOF member margin requirements in real time continuously throughout the trading day. The system issues an alert when a MAOF Clearing House member does not meet clearing house margin requirements. This occurs as a result of changes in the portfolio from the acquisition or sale of derivatives (position change) or from shifts in market conditions (such as a significant fluctuation in the price of the TA-35 index).
In the event that collateral is lacking, the member must transfer Israel government bonds, MAKAM (T-bills) or cash during the trading day in favor of the MAOF Clearing House.
Safety factors for Israeli government bonds/ short-term loans
The safety factor applied for an Israeli government bond / short-term loan (MAKAM) (hereinafter: "bond") is used to adjust the market value of the bond to its value for collateral purposes, taking into account relevant risks.
The safety factors are calculated by the Risk Management Department.
To the safety factor operated by MAOF Clearing House>
More about MAOF Clearing House