• What is pre-trade margining? |
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ActiveMargin™ margins dealers and clients on a pre-trade basis. This means that ActiveMargin™ does not wait for orders and deal requests to become trades before a margin is charged. For example, if an investor has placed an order for +10,000 IBM stock, ActiveMargin™ will immediately ‘charge’ a margin for this order. The order may or may not ultimately become a trade, but the fact is, the order can at any time become a trade, and if the investor has inadequate deposit (or collateral), it becomes too late to do anything by then. Pre-trade margining ensures that all orders are margined, even before they become trades. 
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| • But Pre-Trade margining can lead to unnecessary margins. For instance, assume I have placed a buy order for a December futures contract, and then I place a sell order for a January futures contract of the same underlying. Also assume that the margin for the first order alone is USD 3000, and that for the second order alone is USD 3500. Would you therefore charge a margin of USD 6500 for the above two orders together? If that is the case, why should I pay margins on both the orders, since these orders constitute a hedge? |
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This is precisely the point. In the case cited above, only one of the following 4 cases can happen
- Both orders get executed
- The long order gets executed, while the other does not
- The short order gets executed, while the other does not
- Neither order gets executed
If the 2 orders were mutual hedges, as is the case in this scenario, then the margins payable under (a) and (d) above are very low. Therefore, the margin to be collected is the highest of (b) and (c), (= $ 3500) which is a lot less than the sum of the margins for both the orders separately ($6500).
ActiveMargin™ collects only a margin of $3500 in this case, which is the margin chargeable in the worst case scenario.
Though this simple example illustrates the point, ActiveMargin™ can handle very complex hedge situations, like for example when a portfolio consists of orders from a variety of instrument types (physical, futures, options and swaps) and also from a variety of underlying instruments/factors.
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| • If ActiveMargin™ were to collect the worst case margins after considering the hedge benefits, ActiveMargin™ is going to take a long time to respond. As I see it, if there are 10 unexecuted orders in a client’s order book, and he places a eleventh, the number of scenarios that ActiveMargin™ has to examine is close to 2000. And this increases exponentially with the number of orders. How is ActiveMargin™ going to compute this real-time? |
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ActiveMargin™ uses an optimization algorithm to respond quickly in such situations, so much so, you will find no degradation of performance even when the number of unexecuted orders exceeds 100! And, to be clear, the margin output from ActiveMargin™ is not an approximation – it is the precise margin that will need to be charged in the worst case situation.
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