Safer Margins for Option Trading: How Accuracy Promotes Efficiency
18 Pages Posted: 9 Apr 2008 Last revised: 11 Oct 2013
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Safer Margins for Option Trading: How Accuracy Promotes Efficiency
Safer Margins for Option Trading: How Accuracy Promotes Efficiency
Date Written: May 20, 2009
Abstract
Margin requirements are designed to control the default risk inherent to commitments undertaken by option traders. Much like similar institutions, the Tel Aviv Stock Exchange (TASE) first adopted a system based on the Standard Portfolio Analysis of Risk (SPAN), which sets required levels of options margin according to the most pessimistic of 16 possible outcomes. Seeking to lower the probability of default without adversely affecting liquidity, the TASE switched in 2001 to a more detailed margin system based on the most pessimistic of 44 scenarios. This change provides us with an ideal laboratory for testing the impact of increased margining precision on the efficiency of option trading. Based on a sample of over 3 million transactions, we conclude that the more accurate pricing of default risk over the studied range leads to smaller implied standard deviation and deviation from put-call parity.
Keywords: derivative margins, option margins, SPAN system, option leverage, option default risk, market efficiency
JEL Classification: G11, G13, G14, G20
Suggested Citation: Suggested Citation
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