It’s nearly Christmas and we are all busy eating too much, buying presents and trying to fit in visiting friends and family. It’s also an expensive time of year, and how much this all costs is very dependent on the price of commodities, be it the cocoa used in all those Christmas chocolates, the gold and silver used in those special little gifts or the less expensive metal used in the puzzles preferred by my husband. And then there is the cost of the fuel required for all those visits.

But what has all this got to do with margin? Well, as well as the prices impacting the cost of Christmas, their volatility can also have a big impact on the margin you have to pay if you trade commodity derivatives.

Commodity prices follow the usual economic principles of supply and demand. The only difference is that supply can be severely impacted by external events, for example health scares surrounding cattle (such as foot and mouth), accidents causing mines to be closed, conflict impacting production, or weather ruining a harvest. And that same weather can impact demand; really cold and more fuel is needed for heating or really hot and more electricity is used to run air conditioning.

The drone attack on the Saudi oil facilities in September is a prime example of how events can impact prices. The strike knocked out 5% of global supply.

This caused an initial intraday spike in Brent prices of 20%. By the end of the day, the move had dropped back to just under 15%, but this was still the biggest jump in 30 years.

So what is the impact on margin? Well, in the first instance any large price move will cause an intraday margin call based on the potential losses. In the case of the Brent move this would have been a call for all short position holders based on the 20% move. At the end of the day the actual profits or losses would be realised as variation margin. At this point the move was only 15%, so some traders may have found that some of the cash they provided intraday was returned, whereas others who had sufficient non-cash collateral intraday to cover the potential loss would find themselves having to replace this with cash to cover the variation margin.

The Brent move was large enough to instigate a margin review, with ICE for example increasing the SPAN scanning range by 20%. And because of the way that SPAN works, this would have led to a 20% initial margin increase for all position holders, not just those with short positions.

This is where VaR as a margin algorithm would have made a difference. The increased price volatility would have lead to general uplift in margins, but the big price move as a new historic scenario would only have impacted short position holders.

This highlights the big difference between SPAN and VaR; with VaR the margin is no longer symmetrical, with different amounts being calculated on long and short positions. And for commodities, where you often see a very directional distribution of price moves, this could lead to big differences in margins for different sides of the market.

Both ICE and SPAN are looking to introduce VaR margining for exchange traded derivatives in 2020 and are prioritising commodities. So for those who are potentially going to benefit from this move then maybe you can think of it as an early Christmas present.


The 12 Days of Christmas
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