BSE, CME tie up for risk management of options via SPAN

Our Markets Bureau

Mumbai, May 17: IN a bid to kick off stock specific options trading by July this year, the BSE has formally entered into an agreement with the Chicago Mercantile Exchange (CME) to adopt the latter’s ‘standard portfolio analysis of risk (SPAN)’ system for calculating margin requirements and managing risk in the new era of futures and options.

Following Monday’s ban on badla and other deferred products, the Securities and Exchange Board of India (Sebi) has given permission to the stock exchanges to introduce both index options and options on individual stocks. While the BSE already offers facility to trade in Sensex-based futures, it is fast gearing itself to launch options trading by July this year. The agreement with CME will help the exchange to install a new system for calculating margin requirement and managing risk in the new trading environment that would evolve with the introduction of rolling settlements on the domestic bourses.

According to BSE, it was in 1988 that the CME had introduced its SPAN margining system which is a risk-based, portfolio-approach, simple yet powerful, efficient and accurate system for computing performance bond (margin) requirements for portfolio of futures, options and other derivative and non-derivative instruments.

After the introduction of SPAN, it has become a standard for the derivatives industry. World over, more than 30 exchanges and clearing organisations, including the Tokyo Stock Exchange, the Singapore Exchange and the Hong Kong Futures Exchange, have adopted this system for margin computation and other requirements, a BSE statement said.

Commenting on the tie-up, BSE derivative segment chief executive officer Sanjiv Mehta said: “With the adoption of SPAN, BSE will take a quantum leap in the field of risk management activities.”

Expressing his happiness on entering into an agreement with the BSE, CME’s director (clearing systems development) Ed Gogol said: “We look forward to extend continued co-operation to the BSE as it launches options trading in the near future.”

Further, Mr Mehta said: “The BSE will now be equipped with the latest risk management software which will help the exchange’s margining calculation to be at par with international standards of risk management. We intend to use SPAN not only for risk management of derivatives, but also for recognising risk of sets between cash and the derivatives markets in the future.”

Sebi has already outlined the risk management framework for index options to be adopted by the domestic stock exchanges.

Accordingly, initially it would be the premium style index options that would be permitted. These would have to be settled in cash.

Also, the exchanges would have to adopt a portfolio-based management approach for the futures, options and other derivatives. In the new trading atmosphere, the members of the exchanges would have to take an integrated view of the risk involved in the portfolio of each individual client.

According to Sebi guidelines on the new trading system, this approach is being introduced for the first time in the Indian securities markets and is in lines with the practices being followed globally. A portfolio approach would not only cover the risk but also help in reducing transaction costs in the derivatives.