82,853
edits
When variation margin attacks: Difference between revisions
Jump to navigation
Jump to search
When variation margin attacks (view source)
Revision as of 23:10, 28 November 2021
, 28 November 2021no edit summary
Amwelladmin (talk | contribs) No edit summary |
Amwelladmin (talk | contribs) No edit summary Tags: Mobile edit Mobile web edit |
||
| Line 111: | Line 111: | ||
Swap trading involves [[market risk]] and [[credit risk]]. | Swap trading involves [[market risk]] and [[credit risk]]. | ||
[[Market risk|''Market'' risk]] is the risk that an asset | [[Market risk|''Market'' risk]] is the risk that an asset goes ''up'' when you want it to go ''down'', or ''down'' when you want it to go ''up''. [[Credit risk|''Credit'' risk]] is the risk that the person whom you want to pay you that return cannot, because that she is ''broke''. | ||
[[Variation margin]] is meant to neutralise both: if the day’s loser squares up the value of her loss each day in collateral to the winner, the parties reduce their respective credit exposure to nil: if neither party owes anything on the trade, there is no credit risk. | |||
[[File:Archegos Positions.png|thumb|The purple, blue, light blue and red lines are the key parts of Archegos’ portfolio between March 2020 and August 2021. The big drop is 21 March 2021.]] | [[File:Archegos Positions.png|thumb|The purple, blue, light blue and red lines are the key parts of Archegos’ portfolio between March 2020 and August 2021. The big drop is 21 March 2021.]] | ||
But markets, like sharks, never stop moving. The assessment that “neither party owes anything on the trade” is good for the instant it is made. Things can change quickly. Generally the further something goes up, the quicker it comes down. Let’s have another look at that lovely [[Archegos]] chart: over 6 months from September these stocks rallied on average 54%. | But markets, like sharks, never stop moving. The assessment that “neither party owes anything on the trade” is good only for the instant it is made. Things can change quickly. Generally the further something goes up, the quicker it comes down. | ||
Let’s have another look at that lovely [[Archegos]] chart: over 6 months from September these stocks rallied on average 54%. Then, in just four days, these stocks fell fully half that value. | |||
And here we see the buried credit risk of variation margin. As those positions appreciated, the brokers were obliged to pay their cash value, in VM, to Archegos. Archegos used some of this rising equity to buy more shares in the same stocks, further pushing up their price, obliging the brokers to pay more VM. | |||
You generally have one risk or the other at any time: it is not much good having made | Archegos put ''all'' its cash into more positions. As the stock rose, its absolute position in the shares grew too. | ||
Say it held 100 shares at 40, fully margined. Should they appreciate to 60, it's net equity increases 2,000. Broker credits it with the cash and it buys a further 25 shares at 60, pushing the price to 80. This results in a net equity increase of 4000, to 10000, so the broker pays out 4000 more, Which it used to buy a further 40 shares. Note it's holding is 165 shares and the price surges to 100. Broker dutifully credits a further 6500 in VM, which the customer withdraws and uses to buy another 55 shares, taking is total holding to 220. | |||
Take (er) stock: the stock has rallied 120%. The broker has paid out 12500 is variation margin, to well over 300% of the original investment value. The customer has no cash. | |||
Now the stock retreats to 80. The broker calls for margin, but the customer has no cash. Three customer tries to sell positions but suddenly the ask 50. Even if the customer sold its whole holding at this price — fat chance in a thin falling market, the broker would lose 1500 of its cash. | |||
Once those | |||
You generally have one risk or the other at any time: it is not much good having made a killing on the roulette table if the casino is bankrupt, because it cannot give you any money for your chips. If, on the other hand, you have already lost everything at the card table, it does not matter much if the casino is broke, because it didn’t owe you anything anyway. | |||
Under a swap at any time, the [[out-of-the-money]] counterparty has [[market risk]], because it is losing on the trade, and the [[in-the-money]] one has [[credit exposure]], because it stands to lose if the other guy can’t pay out its profit. [[Variation margin]] addresses that [[Credit risk|''credit'' exposure]] by requiring the [[out-of-the-money]] counterparty pays out variation margin equal to its moneyness, in full, every day even though the game is still going. If things get worse, you have to give some of the variation margin back. If you start losing, you have to pay variation margin to the house. | Under a swap at any time, the [[out-of-the-money]] counterparty has [[market risk]], because it is losing on the trade, and the [[in-the-money]] one has [[credit exposure]], because it stands to lose if the other guy can’t pay out its profit. [[Variation margin]] addresses that [[Credit risk|''credit'' exposure]] by requiring the [[out-of-the-money]] counterparty pays out variation margin equal to its moneyness, in full, every day even though the game is still going. If things get worse, you have to give some of the variation margin back. If you start losing, you have to pay variation margin to the house. | ||
| Line 122: | Line 140: | ||
* [[Variation margin]] | * [[Variation margin]] | ||
*[[Archegos]] | *[[Archegos]] | ||
*[[Swap history]] | *[[Swap history]] | ||
{{ref}} | {{ref}} | ||