Margined option – what is it?
At the beginning of 2008, the FORTS exchange announced the introduction of a new financial instrument called the margined option. For a long time, it remained a major topic of debate among participants of the Russian derivatives market. Today, the controversy has subsided, and it is now possible to assess the results: is this financial market model effective, how does it differ from the traditional one, and was the introduction of margined options truly necessary for the market and its participants?
Origin and Use of Margined Options
There are two methods of settling option transactions: the classic and the margined. The first assumes that a premium is paid at the time of the deal. In the second method, no settlement transactions occur until the contract's expiration. During this time, funds are frozen in the accounts of both parties as margin collateral.
Both calculation methods are valid, and arguing about which is more convenient or effective is pointless. However, in 2009, representatives of the FORTS exchange decided the second model suited them better, and soon all transactions on the exchange became margined. This practice continued until the merger of the RTS stock exchange with the currency exchange, which formed the Moscow Exchange.
Interestingly, margined contracts first appeared in Europe. In fact, Europe is the birthplace of both options themselves and almost all of their new types. In Europe, margined options quickly developed and gained popularity. In the USA, traditionally a leader in options markets, this new type of contract initially did not catch on but gained traction among traders in the 21st century.
On the current Moscow Exchange, margined options are also popular. They are most often used in deals where the underlying asset is currency or derivatives. For trading goods and stocks, classic options are more effective.
As a rule, all margined contracts are cash-settled, meaning they do not involve physical delivery of the underlying asset. Instead, one party compensates the other if the outcome is favorable to their opponent.
Differences Between Margined and Regular Options
When buying/selling a non-margined option, the holder's account is debited the premium, which is immediately transferred to the seller. In a margined deal, no such deduction is made. Instead, the exchange freezes the margin collateral equal to the premium amount.
At the end of each period, the exchange recalculates the variation margin — the difference between the option’s current price and its price at the time of the deal. The variation margin is always positive for one party and negative for the other. The negative variation margin is frozen in the participant’s account, while the positive one is not immediately credited.
You can check interim results of the deal on the official market website or in the trading system. Data is updated at the end of each clearing period — the interval after which the exchange summarizes results. This happens twice a day, at 14:00 and 18:45 Moscow time.
Transfer of funds from one participant’s reserve to another is made only at the close of the deal.
Advantages of Margined Options
1) The main reason margined options were first used was the inconvenience of calculating profit and loss for a cash-settled option. In the new model, the exchange handles the most complex calculations.
2) The model is equally convenient for working with both options and futures.
3) It improves option management when early expiration is needed, since profit and loss can be monitored throughout the day.
4) It optimizes the work of the exchange and its participants.
5) It enables a more accurate assessment of option profitability.
Legal Aspect of Margined Options
Russian legislation allows both physical delivery and cash-settled transactions on the exchange, so the use of a margined option settlement system falls under the main federal laws regulating stock exchanges. The right to supervise such operations belongs to the structural divisions of the Central Bank of Russia.