Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Many brokerage accounts require traders to maintain a margin account when trading options, which involves depositing funds or securities as collateral to reduce the risk of potential losses.
The SPAN system determines margin requirements on options and futures trading accounts by considering key factors, such as volatility, price changes, and portfolio composition to conduct a one-day risk global assessment.
In this sense, options margin is quite different from the margin accounts used for trading stocks and other securities, where margin refers to the use of debt to increase a position.
Key Points
• SPAN stands for Standardized Portfolio Analysis of Risk, and is used by brokerages, investment banks, and exchanges to estimate a portfolio’s worst-case risk scenario for options and futures trading.
• The SPAN system incorporates factors like market volatility, price changes, time decay, and portfolio composition to ensure margin requirements align with a trader’s risk exposure, so there is enough collateral to cover potential losses.
• The SPAN margin calculation evaluates risk scenarios using sophisticated algorithms that automate the margin-setting process.
• Advantages of using SPAN include a holistic portfolio approach and potentially lower margin requirements; disadvantages involve fluctuations in daily margin requirements due to changing market conditions.
• Though the SPAN risk assessment and modeling method was developed for the derivatives markets, it is now employed as a risk-management tool for other financial instruments as well.
What Does SPAN Stand For?
SPAN stands for standardized portfolio analysis of risk, and is a framework used by exchanges and financial institutions to ensure that options and futures traders have enough collateral to cover potential losses.
Today, many derivative exchanges use the SPAN system for risk analysis.
What Is SPAN Margin?
The SPAN margin calculation helps options traders understand risk in their portfolios, and assists brokers in managing risk by ensuring that options and futures margin traders have enough collateral in their accounts to cover potential losses.
The SPAN system relies on algorithmic calculations to estimate a portfolio’s one-day worst-case risk scenario.
SPAN margin is calculated using key inputs such as the strike price, time decay, market volatility, price changes, and position offsets, among other factors.
What Is a Stock Margin Account?
The margin in an options or futures account is different from how a stock margin account functions when making stock trades on margin. When trading stocks and other securities, margin allows traders to use leverage (i.e., borrow funds) to increase their position. The risk of using a margin account is the potential for steep losses, possibly exceeding the initial investment.
By contrast, SPAN is used by options and futures exchanges around the world to determine a trader’s one-day worst-case scenario based on their portfolio positions. This risk modeling ensures the correct amount of collateral is deposited.
Margin requirements can be determined in an automated way from the calculation’s output.
How Does SPAN Margin Work?
The SPAN margin calculation uses modeled risk scenarios to determine margin requirements on options and futures. Some key variables included in the algorithm are strike prices, risk-free interest rates, price changes in the underlying assets, volatility shifts, and the effect of time decay on options.
Not all options positions have margin requirements. Buying options, for example, typically does not require margin, while selling (or writing) options requires a deposit to mitigate potential risks.
In essence, the options seller exposes the broker to risk when they trade. To reduce the risk that the trader won’t be able to pay back the lender, margin requirements establish minimum deposits that must be kept with the broker. (This is different from the margin requirements needed in a stock trading account.)
Instead of relying on fixed or static figures, the SPAN system automates the margin-setting process, relying on sophisticated algorithms and a range of inputs. SPAN margin looks at the worst-case scenario in terms of one-day risk, so the margin requirement output will change each day.
The analysis is done from a total-portfolio perspective since all assets are considered. For example, the SPAN margin calculation can take excess margin from one position and apply it to another.
Pros and Cons of SPAN Margin
There are upsides and downsides to SPAN margin in options and futures trading.
The Advantages
The key advantage of SPAN margins is that it is intended to cover potential losses.
Net option sellers benefit from SPAN’s holistic portfolio approach. SPAN combines options positions when assessing risk. If you have an options position with a substantial risk in isolation, but another options position that offsets that risk, SPAN considers both. The effect is a potentially lower margin requirement.
On top of that, futures options exchanges that use the SPAN margin calculation allow Treasury bills to be margined.
The Downsides
Changing market conditions can result in significant fluctuations in daily margin requirements.SPAN margin isn’t without its challenges. One big drawback is how much margin requirements can shift from day to day. If the market gets volatile or prices move suddenly, you might find yourself scrambling to meet a higher margin call to keep your positions open.
Another issue is the complexity. SPAN’s calculations aren’t always easy to follow, especially for newer traders. Unlike simpler, fixed-margin systems, SPAN relies on a lot of variables, so you might not always know what to expect with your margin needs.
Although SPAN’s portfolio-wide approach is helpful, it can sometimes create confusion. Margin offsets across different positions might be hard to follow unless you’re closely tracking how everything is allocated. This makes it important to stay on top of your portfolio and understand how SPAN applies to your trades.
The Takeaway
SPAN margin is a helpful risk-management tool for options trading. Algorithms determine margin requirements based on a one-day risk analysis of a trader’s account, taking into consideration factors such as market volatility and position size.
By considering the entire portfolio, SPAN helps ensure that margin requirements are in line with a trader’s risk exposure. This provides a more dynamic, accurate approach to managing risk.
SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.
With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
FAQ
What does SPAN stand for in margin trading?
SPAN margin stands for “standardized portfolio analysis of risk.” It is a system used by many options and futures exchanges worldwide to gauge a portfolio’s risk level, and ensure that the trader has enough collateral to cover potential losses.
How is SPAN margin used?
SPAN margin is used to manage risk. It calculates the amount of good-faith deposit a trader must add to their account in order to engage in options or futures trading. To help ensure that traders maintain adequate collateral for their positions, mitigating risks to the broker, exchanges use the SPAN system to calculate a worst possible one-day outcome and set a margin requirement accordingly.
What is a SPAN calculation?
SPAN is calculated using risk assessments. That means an array of possible outcomes is analyzed based on different market conditions using the assets in a portfolio. These risk scenarios specify certain changes in variables such as price changes, volatility shifts, and decreasing time to expiration in options trading.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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