STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)

Chapter 11
I. SPAN Overview
II. Ava!ta"e# a! Ratio!a$e of SPAN
III. Optio! %&'it( a! Ri#) *ar"i!
I+. *ar"i! Ca$,'$atio!#
+. Ri#) Arra(#
+I. F't're# S,a! Ra!"e
+II. +o$ati$it( S,a! Ra!"e
+III. %-tre.e *ove S,e!ario
I/. Other Fa,tor# Affe,ti!" SPAN *ar"i! Re&'ire.e!t#
/. A Si.p$e *ar"i! Ca$,'$atio!
STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)
SPAN Overview
Deve$ope 0( the Chi,a"o *er,a!ti$e %-,ha!"e i! 11223 the Sta!ar Portfo$io
A!a$(#i# of Ri#) (SPAN) perfor.a!,e 0o! .ar"i!i!" #(#te. for ,a$,'$ati!"
re&'ire.e!t# ha# 0e,o.e the f't're# i!'#tr( #ta!ar.
SPAN eva$'ate# the ri#) of a! e!tire a,,o'!t4# f't're#5optio!# portfo$io a!
a##e##e# a .ar"i! re&'ire.e!t 0a#e o! #',h ri#). It a,,o.p$i#he# thi# 0(
e#ta0$i#hi!" rea#o!a0$e .ove.e!t# i! f't're# pri,e# over a o!e a( perio. The
re#'$ti!" effe,t of the#e 6ri#) arra(#7 i# to ,apt're re#pe,tive "ai!# or $o##e# of
f't're# a! optio!# po#itio!# withi! that ,o..oit(. %a,h %-,ha!"e .ai!tai!#
the re#po!#i0i$it( of eter.i!i!" the#e ri#) arra(# a# we$$ a# the optio!
,a$,'$atio!# that are !eee to eter.i!e the effe,t of vario'# f't're# pri,e
.ove.e!t# o! optio! va$'e#.
Ava!ta"e# a! Ratio!a$e of SPAN
SPAN re,o"!i8e# the #pe,ia$ ,hara,teri#ti,# of optio!#3 a! #ee)# to a,,'rate$(
a##e## the i.pa,t o! optio! va$'e# fro. !ot o!$( f't're# pri,e .ove.e!t#
0't a$#o ,ha!"e# i! .ar)et vo$ati$it( a! the pa##a"e of ti.e. The e! re#'$t
i# that the .i!i.'. .ar"i! o! the portfo$io wi$$ .ore a,,'rate$( ref$e,t the
i!here!t ri#) i!vo$ve with tho#e po#itio!# a# a who$e.
Optio! %&'it( a! Ri#) *ar"i!
O!e of the #pe,ia$ ,hara,teri#ti,# of optio!# i# that a $o!" optio! po#itio! ,a!
!ever 0e at ri#) for .ore tha! it# pre.i'.. I! orer for SPAN to a##e## the ri#) of
a$$ po#itio!# i! the portfo$io a! at the #a.e ti.e a$$ow ,reit for the pre.i'.
i!vo$ve3 SPAN a$$ow# the e-,e## of the optio! pre.i'. over the ri#) .ar"i! for
a!( optio! po#itio! to 0e app$ie to the ri#) .ar"i! o! other po#itio!#.
*ar"i! Ca$,'$atio!#
9!er SPAN3 fir.# wi$$ re,eive ri#) arra(# fro. the re#pe,tive ,$eari!"
or"a!i8atio!# to ,a$,'$ate .ar"i!# for their a,,o'!t#. The#e fir.# wi$$ the!
,a$,'$ate .i!i.'. .ar"i! re&'ire.e!t# for a$$ of it# a,,o'!t# 0a#e o! the
arra(# o! a ai$( 0a#i#. I!ivi'a$# are a0$e to ,a$,'$ate their ow! .ar"i!
re&'ire.e!t# thro'"h $oai!" the ri#) arra(# a! their po#itio!# i!to PC:SPAN.
Ri#) Arra(#
9!er SPAN3 ea,h %-,ha!"e wi$$ provie ri#) arra(# for ea,h ,o..oit( trae.
The#e arra(# are ,o.pri#e of 1; 6what if7 #,e!ario# that ,over a ra!"e of
rea#o!a0$e f't're# pri,e a! vo$ati$it( ,ha!"e# over the ,o'r#e of a a(. For
11 : 1 <'$( 1111
STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)
e-a.p$e3 what if ,r'e oi$ f't're# pri,e# ro#e 0( =1 a! vo$ati$it( o! ,r'e oi$
optio!# fe$$> %a,h #,e!ario .ea#'re# the i.pa,t o! profit a! $o## of the
h(potheti,a$ .ove.e!t# o! f't're# a! optio!# po#itio!# withi! that ,o..oit(.
%a,h a!#wer 0e,o.e# a ,o.po!e!t of the ri#) arra(3 a! SPAN wi$$ ta)e the
$ar"e#t $o## fro. that arra( a# the .i!i.'. .ar"i! for the a(. I! orer to
,o!#tr',t arra(#3 ea,h %-,ha!"e provie# 0oth the f't're# a! vo$ati$it( #,a!
ra!"e#.
F't're# S,a! Ra!"e
The f't're# #,a! ra!"e i# e&'a$ to a fir.4# .ai!te!a!,e .ar"i! re&'ire.e!t for
o'tri"ht po#itio!#. Thi# repre#e!t# the i!terva$ that a f't're# ,o!tra,t4# pri,e#
are $i)e$( to .ove ('p or ow!) over a #i!"$e a(. For e-a.p$e3 if the #,a! ra!"e
i# =13?@@ for ,r'e oi$ ,o!tra,t#3 it i.p$ie# that ,r'e oi$ f't're# pri,e# are .o#t
$i)e$( to f$',t'ate withi! a 0a! of =1.?@50arre$ 'p or ow! (#i!,e ea,h ,o!tra,t
repre#e!t# 13@@@ 0arre$#) fro. the $a#t #ett$e.e!t pri,e. To ,o!#tr',t the ri#)
arra(#3 SPAN #et# fra,tio!# (.'$tip$e# of 15A) of the ra!"e 0oth 'p a! ow! a#
the p$a'#i0$e pri,e ,ha!"e#. %a,h ,o..oit( trae ha# it# ow! #,a! ra!"e.
+o$ati$it( S,a! Ra!"e
I! aitio! to f't're# pri,e ,ha!"e#3 a .aBor eter.i!a!t of optio! va$'e i# the
i!here!t vo$ati$it( that i# e-pe,te i! the .ar)et. %a,h %-,ha!"e wi$$ #et
para.eter#3 0oth 'p a! ow!3 for $i)e$( ,ha!"e# i! e-pe,te .ar)et vo$ati$it(.
The i.pa,t o! optio! va$'e of the#e h(potheti,a$ ,ha!"e# are the! '#e to
,apt're the profit (or $o##) o! optio! po#itio!#3 a! he!,e the ri#) of optio!# i! a
"ive! portfo$io.
%-tre.e *ove S,e!ario
%a,h %-,ha!"e wi$$ #et a! e-tre.e .ove para.eter3 '#'a$$( #et e&'a$ to a
.'$tip$e of the f't're# #,a! ra!"e3 a# we$$ a# a per,e!t of thi# .ove it 0e$ieve# it
!ee# to 0e ,overe for po##i0$e a0r'pt ,ha!"e# of f't're# pri,e#.
Si-tee! 6Chat If7 S,e!ario#
1. F't're# '!,ha!"e3 vo$ati$it( 'p
D. F't're# '!,ha!"e3 vo$ati$it( ow!
A. F't're# 'p 15A ra!"e3 vo$ati$it( 'p
E. F't're# 'p 15A ra!"e3 vo$ati$it( ow!
?. F't're# ow! 15A ra!"e3 vo$ati$it( 'p
11 : D <'$( 1111
STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)
;. F't're# ow! 15A ra!"e3 vo$ati$it( ow!
F. F't're# 'p D5A ra!"e3 vo$ati$it( 'p
2. F't're# 'p D5A ra!"e3 vo$ati$it( ow!
1. F't're# ow! D5A ra!"e3 vo$ati$it( 'p
1@. F't're# ow! D5A ra!"e3 vo$ati$it( ow!
11. F't're# 'p A5A ra!"e3 vo$ati$it( 'p
1D. F't're# 'p A5A ra!"e3 vo$ati$it( ow!
1A. F't're# ow! A5A ra!"e3 vo$ati$it( 'p
1E. F't're# ow! A5A ra!"e3 vo$ati$it( ow!
1?. F't're# 'p e-tre.e .ove
(,over A?G of $o##)
1;. F't're# ow! e-tre.e .ove
(,over A?G of $o##)
Other Fa,tor# Affe,ti!" SPAN *ar"i! Re&'ire.e!t#
I! aitio! to the a0ove ri#) arra(#3 ea,h %-,ha!"e wi$$ a$#o a##e## i!ter.o!th
#prea ,har"e#3 i!ter,o..oit( #prea ,reit#3 a! #hort optio! .i!i.'.
.ar"i!#. The#e wi$$ affe,t the fi!a$ .ar"i! re&'ire.e!t# for $ar"e portfo$io#.
The i!ter.o!th #prea ,har"e# repre#e!t aitio!a$ .ar"i! pa(.e!t# that are
a##e##e o! po#itio!# o! iffere!t ,o!tra,t .o!th# withi! a ,o..oit( that are
o! oppo#ite #ie# of the .ar)et. Thi# i# to ,apt're the ri#) that pri,e ,ha!"e#
0etwee! iffere!t ,o!tra,t .o!th# of the #a.e ,o..oit( ofte! o !ot .at,h
ea,h other e-a,t$(. I! fa,t3 there are ofte! ti.e# whe! iffere!t ,o!tra,t .o!th#
withi! the #a.e ,o..oit( e-perie!,e oppo#ite pri,e ,ha!"e. Si!,e thi#
#'""e#t# a hi"her
$eve$ of ri#) to the portfo$io3 a! aitio!a$ .ar"i! ,har"e i# a##e##e to the#e
#prea po#itio!#.
SPAN a$#o re,o"!i8e# that .a!( ,o..oitie# te! to e-perie!,e #i.i$ar pri,e
.ove.e!t#. For off#etti!" po#itio!# i! iffere!t ,o..oitie# that are re$ate3
SPAN a$$ow# ,ertai! ,reit# 0e "ive! to the portfo$io4# tota$ .ar"i! to ref$e,t thi#
$ower overa$$ ri#).
Fi!a$$(3 '!$i)e $o!" optio! po#itio!# whi,h have a .a-i.'. pote!tia$ $o##3 the
va$'e of the optio! pre.i'.3 #hort optio!# have virt'a$$( '!$i.ite ri#). SPAN
a,,o'!t# for thi# ,hara,teri#ti, of #hort optio! po#itio!# 0( havi!" a .i!i.'.
.ar"i! a##e##e3 re"ar$e## of the $o##e# eter.i!e i! the a0ove ri#) arra(#.
%a,h %-,ha!"e .ai!tai!# the re#po!#i0i$it( of #etti!" the i!ter.o!th #prea
,har"e3 the i!ter,o..oit( #prea ,reit3 a! the #hort optio! .i!i.'. .ar"i!.
A Si.p$e *ar"i! Ca$,'$atio!
11 : A <'$( 1111
STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)
A##'.e a po#itio! ,o!tai!# a #i!"$e $o!" <a!'ar( Cr'e Oi$ f't're# ,o!tra,t.
A##'.i!" a! '!er$(i!" f't're# pri,e of =D@3 a SPAN f't're# #,a! ra!"e of
=13?@@3 a! vo$ati$it( #,a! ra!"e of DG. The ri#) arra( wo'$ $oo) $i)e the
fo$$owi!"H
SC%NARIO +AL9% LOSS
1. F't're# '!,ha!"e3 vo$ati$it( 'p =@
D. F't're# '!,ha!"e3 vo$ati$it( ow! =@
A. F't're# 'p 15A ra!"e3 vo$ati$it( 'p :=?@@
E. F't're# 'p 15A ra!"e3 vo$ati$it( ow! :=?@@
?. F't're# ow! 15A ra!"e3 vo$ati$it( 'p =?@@
;. F't're# ow! 15A ra!"e3 vo$ati$it( ow! =?@@
F. F't're# 'p D5A ra!"e3 vo$ati$it( 'p :=13@@@
2. F't're# 'p D5A ra!"e3 vo$ati$it( ow! :=13@@@
1. F't're# ow! D5A ra!"e3 vo$ati$it( 'p =13@@@
1@. F't're# ow! D5A ra!"e3 vo$ati$it( ow! =13@@@
11. F't're# 'p A5A ra!"e3 vo$ati$it( 'p :=13?@@
1D. F't're# 'p A5A ra!"e3 vo$ati$it( ow! :=13?@@
1A. F't're# ow! A5A ra!"e3 vo$ati$it( 'p =13?@@
1E. F't're# ow! A5A ra!"e3 vo$ati$it( ow! =13?@@
1?. F't're# 'p e-tre.e .ove (,over A?G of $o##) :=13@?@
1;. F't're# ow! e-tre.e .ove (,over A?G of $o##) =13@?@
S,a!!i!" the va$'e $o## ,o$'.!3 =13?@@ ,a! 0e #ee! to 0e the wor#t ,a#e $o##3
a! therefore 0e,o.e# the .ar"i!. Thi# a$#o happe!# to 0e the o'tri"ht .ar"i!
$eve$3 whi,h i$$'#trate# that for #i.p$e o'tri"ht po#itio!#3 .ar"i! $eve$# wi$$ 0e #et
the #a.e wa( a# the( are ,'rre!t$( e#ta0$i#he.
S'ppo#e a po#itio! ,o!tai!# o!e #hort <a!'ar( =D@ Cr'e Oi$ Ca$$ Optio!. The
ri#) arra( wo'$ $oo) $i)e the fo$$owi!"H
SC%NARIO +AL9% LOSS
1. F't're# '!,ha!"e3 vo$ati$it( 'p =AF
D. F't're# '!,ha!"e3 vo$ati$it( ow! :=?D
A. F't're# 'p 15A ra!"e3 vo$ati$it( 'p =AA1
E. F't're# 'p 15A ra!"e3 vo$ati$it( ow! =D??
?. F't're# ow! 15A ra!"e3 vo$ati$it( 'p :=1F@
;. F't're# ow! 15A ra!"e3 vo$ati$it( ow! :=D?D
11 : E <'$( 1111
STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)
F. F't're# 'p D5A ra!"e3 vo$ati$it( 'p =;1;
2. F't're# 'p D5A ra!"e3 vo$ati$it( ow! =;AA
1. F't're# ow! D5A ra!"e3 vo$ati$it( 'p :=A1F
1@. F't're# ow! D5A ra!"e3 vo$ati$it( ow! :=AFE
11. F't're# 'p A5A ra!"e3 vo$ati$it( 'p =111?
1D. F't're# 'p A5A ra!"e3 vo$ati$it( ow! =13@F?
1A. F't're# ow! A5A ra!"e3 vo$ati$it( 'p :=A;1
1E. F't're# ow! A5A ra!"e3 vo$ati$it( ow! :=ED1
1?. F't're# 'p e-tre.e .ove (,over A?G of $o##) =21@
1;. F't're# ow! e-tre.e .ove (,over A?G of $o##) :=1?1
To eter.i!e the .ar"i!3 SPAN ta)e# the .a-i.'. $o## fro. the ri#) arra(#
(!oteH !e"ative va$'e# refer to "ai!#). I! the a0ove e-a.p$e3 the .ar"i! re#o$ve#
to $i!e 11H =1311?.
A #o.ewhat .ore ,o.p$i,ate e-a.p$e wo'$ 0e if we ,o.0i!e the two #i.p$e
po#itio!# a0ove. Ai!" the two ri#) arra( re#'$t# i! the fo$$owi!"H
SC%NARIO +AL9% LOSS
1. F't're# '!,ha!"e3 vo$ati$it( 'p =AF
D. F't're# '!,ha!"e3 vo$ati$it( ow! :=?D
A. F't're# 'p 15A ra!"e3 vo$ati$it( 'p :=1;1
E. F't're# 'p 15A ra!"e3 vo$ati$it( ow! :=DE?
?. F't're# ow! 15A ra!"e3 vo$ati$it( 'p =AA@
;. F't're# ow! 15A ra!"e3 vo$ati$it( ow! =DE2
F. F't're# 'p D5A ra!"e3 vo$ati$it( 'p :=A@E
2. F't're# 'p D5A ra!"e3 vo$ati$it( ow! :=A;F
1. F't're# ow! D5A ra!"e3 vo$ati$it( 'p =;2A
1@. F't're# ow! D5A ra!"e3 vo$ati$it( ow! =;D;
11 : ? <'$( 1111
STANDARD PORTFOLIO ANALYSIS of RISK (SPAN)
11. F't're# 'p A5A ra!"e3 vo$ati$it( 'p :=A2?
1D. F't're# 'p A5A ra!"e3 vo$ati$it( ow! :=ED?
1A. F't're# ow! A5A ra!"e3 vo$ati$it( 'p =131@E
1E. F't're# ow! A5A ra!"e3 vo$ati$it( ow! =13@F1
1?. F't're# 'p e-tre.e .ove (,over A?G of $o##) :=1;@
1;. F't're# ow! e-tre.e .ove (,over A?G of $o##) =211
I! thi# ,a#e the wor#e ,a#e $o## re#o$ve# to =131@E.

11 : ; <'$( 1111