Nicole Seaman

Director of FRM Operations
Staff member
Learning objectives: Describe how exchanges can be used to alleviate counterparty risk. Explain the developments in clearing that reduce risk. Describe netting and describe a netting process ... Describe the role of collateralization in the OTC market and compare it to the margining system. Explain the use of special purpose vehicles (SPVs) in the OTC derivatives market.


21.10.1. Derivatives can trade either on an exchange or over-the-counter (OTC). By definition, futures trade on an exchange. Many of the large exchanges vertically own their own central counterparty (CCP), as a division. Horizontal CCPs are owned by the clearing members. Although often conflated, the pre-trade price transparency provided by the exchange is distinct from the risk mitigation provided by the CCP. In regard to a futures exchange and/or its vertically owned CCP (aka, futures market that trades futures contract), each of the following statements is TRUE except which is false?

a. In regard to futures contracts, CCPs do not pay interest on initial margin but they must pay interest on variation margin
b. While "margin" traditionally referred to collateral in an exchange-traded market, it can also refer to collateral in the OTC market
c. Initial margin is a function of the volatility of the futures price and an estimation of time required to close out the member if the member defaults
d. Because the number of long positions is equal to the number of short positions, the flow of variation margin through the CCP is from members who are net long (or net short) to members who are net short (or net long) but there is no net cash inflow or outflow to the CCP

21.10.2. A trader shorts 500 shares when the stock price is $70.00. The initial and maintenance margin, respectively, are 150.0% and 125.0%. At what share price will further margin be required?

a. $65.00
b. $72.00
c. $79.00
d. $84.00

21.10.3. A trader writes 300 put options; aka, she takes a short position in three put option contracts. Each put option has a premium of $2.70 and the strike price is $20.00 while the stock price is $23.00; that is, the written put options are 15% out-of-the-money. For naked options, the following are the margin requirements:

For a short call (put) option, the margin requirement is the greater of:
  • 100% of the value of the option plus 20% of the underlying stock price less the amount (if any) that the option is out-of-the-money, or
  • 100% of the value of the option plus 10% of the underlying stock (strike) price.
What is the margin requirement for this trade?

a. Zero
b. $1,500.00
c. $2,190.00
d. $6,000.00

Answers here: