CME to Raise Margins at End of Business Today and on Monday 5/9/11

CME to Raise Margins on Monday

(Reuters) – The CME Group (CME.O) sharply raised silver futures margins for a fourth and fifth time in under two weeks, an 84 percent rise in trading costs that has helped provoke a nearly unprecedented sell-off.

The 20 percent slide in silver prices since they touched an all-time high of $49.51 an ounce on April 28 has been in large part driven by selling from speculators who may be unable or unwilling to bear the surging cost of holding positions.

Holdings in the world’s largest silver-backed exchange-traded fund, iShares Silver Trust, fell by 521.8 tons, or 4.78 percent, from the previous session to 10,387.26 tons by May 4.

These things are not subject to manipulation as much as ridiculous margin requirements?  – Jim Cramer CNBC

The CME, which typically raises margins when volatility in markets increases, dealt the latest blow on Wednesday, announcing two separate, successive margin hikes.

It said margins would rise to $14,000 per contract from$12,000 effective Thursday, May 5, and again to $16,000 effective Monday, May 9. Prior to April 25 the margin stood at $8,700 per contract. One contract holds 5,000 ounces, worth about $200,000 at current prices.

“The catalyst for the silver move could be the margin requirement hikes, squeezing out the pure short-term speculators that were playing a hot segment,” said Joe Cusick, senior market analyst at Chicago-based online brokerage optionsXpress.

Silver prices tumbled 5 percent on Wednesday, taking three-day losses to 18 percent, only the sixth time since 1983 that prices have fallen so sharply in such a short time.

The volatile silver market has become a hot topic in financial circles over the past six months as it surged more than 170 percent from August, outstripping gold’s one-third rise and attracting a flow of trend-chasing money.

But its recent ructions have shocked even veterans, with implied volatility in the options market surging from 37 percent to a post-2008 high of more than 55 percent in just two weeks, according to Reuters data based on 30-day at-the-money call options traded on COMEX.

Directly from CME Group

With recent geopolitical events and natural disasters driving volatility in financial markets, margins – good-faith deposits to guarantee performance on open positions – have spent more time than usual under the limelight.

So we thought it might help to provide a very brief primer on margins as part of this conversation.

At CME Group, we’re intently focused on risk management. In over a century, we have not experienced a default. In more than a century, there has never been a failure by a clearing member to meet a performance bond call or its delivery obligations; nor has there been a failure of a clearing member firm resulting in a loss of customer funds. As part of our overall risk management program, margins are adjusted frequently across all of our products based on market volatility. When daily price moves become more volatile, we typically raise margins to account for the increased risk. Likewise, when daily price moves become less volatile, margins typically go down because the risk of the position also decreases.

Margins are set as part of the neutral risk management services we provide. They aren’t a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another. Rather, margin is one of many risk management tools that help us assess overall portfolio risk to protect market participants and the market as a whole.

There are two main margin philosophies that clearing houses can have. First, a clearing house could set margins sufficiently high to cover all possible volatility environments. Changes are less frequent, but margins are higher. Second, and the CME Clearing approach, is to ensure that margins are set to cover 99 percent of the potential price moves. Margins then are lower in less volatile periods and higher in more volatile periods. Changes are often made when the volatility environment experiences a sustained change.

Who determines margin, and what goes into setting margin levels?

At CME Group, CME Clearing is responsible for setting margins. In doing so, we consider several factors to compute the gains and losses a portfolio would incur under different market conditions. Then we calculate the worst possible loss a portfolio might reasonably incur in a set time (usually one trading day for futures markets).

CME Clearing determines “initial margin,” which is the margin that market participants must pay when they initiate their position with their clearing firm, as well as “maintenance margin,” the level at which market participants must maintain their margin over time. We mark positions to market twice a day to prevent losses from accumulating over time. We typically change margins after a market closes because we have a full view of the market liquidity of that trading day. And, we also provide at least 24 hours notice of margin changes to give market participants time to assess the impact on their position and make arrangements for funding.

In the case of silver, we have made several changes in margin in recent weeks to adjust to volatility in the marketplace. By the close of business Thursday, May 5, the margin when a position is initiated will be $18,900; throughout the life of that trade, we would expect $14,000 in maintenance margin would be kept at the clearing house. By the close of business Monday, May 9, the margin when a position is initiated will be $21,600, and we would expect open positions to keep $16,000 in maintenance margin at the clearing house. This is similar to when you sign up for a checking account – a bank will typically require a minimum initial deposit and can then stipulate that you maintain a certain balance going forward.

It also is important to mention that the way margins are calculated has to be tailored to the market served. For example, portfolio margins for our listed derivatives are based on the CME Standard Portfolio Analysis of Risk (SPAN). CME SPAN is the industry standard for portfolio margins used by more than 50 other global exchanges, clearing organizations, service bureaus and regulatory agencies. Margins for credit default swaps and interest rate swaps are quite different because those markets behave differently and have different kinds of variables that produce risk.

As an industry-leading clearing provider, our risk management methodologies have to work to protect the markets we serve. Our interest is in providing security for the entire market – no matter which way it moves.

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