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When variation margin attacks: Difference between revisions
When variation margin attacks (view source)
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Now: because a synthetic swap position looks like a bilateral derivative — okay, okay: ''is'' a bilateral derivative — it is regulated as such, and is in scope for mandatory variation margin. ''Both'' sides are obliged to post [[VM]], every day, where they are [[out-of-the-money]]. Whenever a customer makes any positive return on an [[equity swap]], its swap dealer is, technically, [[out-of-the-money]], and must therefore post [[variation margin]] to the value of that positive return. | Now: because a synthetic swap position looks like a bilateral derivative — okay, okay: ''is'' a bilateral derivative — it is regulated as such, and is in scope for mandatory variation margin. ''Both'' sides are obliged to post [[VM]], every day, where they are [[out-of-the-money]]. Whenever a customer makes any positive return on an [[equity swap]], its swap dealer is, technically, [[out-of-the-money]], and must therefore post [[variation margin]] to the value of that positive return. | ||
This is the equivalent of forcing the swap dealer to lend against equity on a margin loan. It is ''nuts''. To see why it is nuts, let’s return to our old friends at Archegos. | This is the equivalent of forcing the swap dealer to lend against equity on a margin loan. It is ''nuts''. To see ''why'' it is nuts, let’s return to our old friends at [[Archegos]]. | ||
==When variation margin attacks== | ==When variation margin attacks== | ||
Swap trading involves [[market risk]] and [[credit risk]]. | |||
[[Market risk|''Market'' risk]] is the risk that an asset in which you have invested 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 who has promised to pay you a return cannot, because that person is ''broke''. Paying [[variation margin]] is meant to neutralise both: by squaring up every day, you reduce the market 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.]] | |||
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%. That is a ''lot'' of variation margin to be paying out the door. But in four days, between 22-26 March 2021, these stocks fell on average by 24%. | |||
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. | |||
{{Sa}} | {{Sa}} | ||