Options trading is far more complex than trading stocks and exchange-traded funds (ETFs). Trading and valuing options includes many variables including intrinsic value and time value, implied volatility, and weighing changes in interest rates.
The SPAN system determines margin requirements on options accounts by considering many inputs along with a portfolio’s global (total) assets to conduct a one-day risk assessment. This article will dive deep into how SPAN works and what investors need to know about it.
What Does SPAN Stand For?
SPAN stands for standardized portfolio analysis of risk, and is an algorithm used in options and futures margin trading.
What Is SPAN Margin?
The SPAN margin calculation helps options traders understand risk in their accounts and assists brokers in managing risk. 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. Margin requirements can be set in an automated way from the calculation’s output.
Unlike the margin in a stock trading account, which is essentially just a loan from a broker, the margin in an options or futures account is considered a good-faith deposit or a performance bond. It is helpful to understand how a margin account functions before trading complex strategies.
How Does SPAN Margin Work?
The SPAN margin calculation uses modeled risk scenarios to determine margin requirements on options and futures. The primary 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.
While buying options typically does not require margin, writing (or shorting) options requires a deposit. In essence, the options seller exposes the broker to risk when they trade. To reduce the risk that the trader cannot pay back the lender, margin requirements establish minimum deposits that must be kept with the broker.
Rather than using arbitrary figures, the SPAN system automates the margin setting process, using algorithms and many sophisticated inputs to determine margin requirements. 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 the 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.
SPAN margin also imposes requirements on options and futures contract sellers, known as writers. Traders who are short derivatives contracts often expose the lender to greater risk since losses can be unlimited depending on the positions taken. The broker wants to ensure their risk is protected if the market turns against options and futures writers.
Pros and Cons of SPAN Margin
There are upsides and downsides to SPAN margin in options and futures trading.
The Advantages
Futures options exchanges that use the SPAN margin calculation allow Treasury Bills to be margined. Though fees are typically also imposed by many clearinghouses, the interest earned on the Treasurys may help offset transaction costs if interest rates are high enough.
There is another upside: 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.
The Downsides
While SPAN is savvy enough to look at both pieces of an option seller’s combination trade, there are never perfect hedges. Many variables are at play in derivatives markets. There can still be strict margin levels required based on SPAN margin’s one-day risk assessment.
Summary
| Pros | Cons |
|---|---|
| Determines margin requirements from an overall portfolio perspective | There still might be high margin requirements when two positions do not offset |
| Traders know their margin amount each day based on the latest market variables | Changing market conditions can mean big shifts in day-to-day SPAN margin amounts |
| Margin deposits in options or futures accounts can collect interest |
SPAN and Exposure Margin
Exposure margin is the margin blocked over and above the SPAN margin amount to protect against any mark-to-market losses. Like SPAN margin, exposure margin is set by an exchange. The exchange will block off your entire initial margin (both SPAN margin and exposure margin) when you initiate a futures transaction.
The Takeaway
SPAN margin is helpful to manage risks in trading markets. Algorithms determine margin requirements based on a one-day risk analysis of a trader’s account. While primarily used in futures trading and when writing options, investors should know about this critical tool in financial markets.
Margin accounts come with a unique set of risks and rewards. You can learn more about margin trading with SoFi’s resources.
You can also explore investing options on the SoFi Invest® app. It allows members to research investment opportunities based on their individual risk and return objectives.
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.
How is SPAN margin used?
SPAN margin is used to manage risk in trading markets. It calculates the suggested amount of good-faith deposit a trader must add to their account in order to engage in options or futures trading. To help mitigate the risk that traders will not be able to pay back the funds the broker lends them, exchanges use the SPAN system to calculate a worst possible one-day outcome and set a margin requirement accordingly. SPAN margin reduces the risk of a trader growing their leverage ratio too high based on the automated risk calculations. SPAN margin can also allow lower margin requirements for options sellers who trade multiple positions.
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.
Inputs into a SPAN calculation include strike prices, risk-free interest rates, price changes in underlying assets, implied volatility changes, and time decay. After calculating the margin on each position, SPAN can shift excess margin on a single position to other positions that might be short on margin. It is a sophisticated tool that considers a trader’s entire portfolio.
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