The Standard Portfolio Analysis of Risk™ (SPAN) system is a highly sophisticated methodology that calculates performance bond requirements by analyzing the "what-ifs" of virtually any market scenario. Developed and implemented in 1988 by Chicago Mercantile Exchange (CME), SPAN was the first system ever to calculate performance bond requirements exclusively on the basis of overall portfolio risk at both clearing and customer levels.

How does SPAN work?

SPAN evaluates overall portfolio risk by calculating the worst probable loss that a portfolio might reasonably incur over a specified time period.
SPAN achieves this number by comparing hypothetical gains and losses that a portfolio would sustain under different market conditions.
SPAN typically provides a "Risk Array" analysis of 16 possible scenarios for a specific portfolio under various conditions.
SPAN methodology, however, allows users to request any number of scenarios to meet their particular needs:

• Each scenario consists of a "what-if" situation in which SPAN assesses the effects of variations in price, volatility and time to expiration.
• Each calculation represents a gain or loss based on the possible gains or losses due to changes in an instrument´s price by X and volatility by Y.

What type of SPAN parameters does Variance Futures determine?

Variance Futures and your clearing FCM determine the following SPAN parameters, in order to reflect the risk coverage desired in any particular market:

• Price Scan Range: A set range of potential price changes
• Volatility Scan Range: A set range of potential implied volatility changes
• Intracommodity Spread Charge: An amount that accounts for risk (basis risk) of calendar spreads or different expirations of the same product, which are not perfectly correlated
• Short Option Minimum: Minimum margin requirement for short option positions Spot Charge: A charge that covers the increased risk of positions in deliverable instruments near expiration
• Intercommodity Spread Credit: Margin credit for offsetting positions between correlated products

SPAN combines financial instruments within the same underlying for analysis, and refers to this grouping as the Combined Commodity group. For example, futures, options on futures and options on equities on the same stock could all be grouped under a single Combined Commodity.

To calculate a performance bond requirement, for each Combined Commodity in a portfolio, SPAN will:

• Sum the Scan Risk charges, any Intracommodity Spread and Spot Charges
• Apply the offsets for all Intercommodity Spread Credits within the portfolio
• Compare the above sum with any existing Short Option Minimum requirement
• Assess the greater of the two compared as the risk of the Combined Commodity

The Total Margin Requirement for a portfolio is the sum of the risk of all Combined Commodities less all credit for risk offsets between the different Combined Commodities.

Risk Array Graph

Example for SPAN calculation

Here's an example of a portfolio with CME Euro FX Futures and Options positions:

• Euro FX Futures: 1 Long June07
• Euro FX Options on Futures: 1 Short June/June07 Call 1.150 Strike
• Euro FX June Futures Settlement = 1.1960
• Euro FX Futures Price Scan Range = $2400 = 192 points
• Euro FX Volatility Scan Range = 1%

In the sample portfolio above, in scenario 8, the gain on 10 long June 04 EC futures position offsets the loss of one short 10 EC June/June 04 1.150 call option position, incurring a gain of $3600.

In scenario 16, the portfolio would incur a loss of $8380 over the next trading day, which is 32% of the resulting loss if the price of the underlying future decreases by three times the price scan range.

After SPAN has scanned the different scenarios of underlying market price and volatility changes, it selects the largest loss among these observations. This "largest reasonable loss" is the Scan Risk charge.
In this example, the largest loss across all 16 scenarios is a result of Scenario 16, a loss of $8380.