The Risk Based Haircut methodology may be used to calculate theoretically based capital charges as set forth within the SEC net capital rule (15c3-1 under the Securities Exchange Act of 1934). It applies options price theory and portfolio theory to positions involving listed options for the computation of capital charges. Under the risk based method, options price theory is utilized to project portfolio liquidating values under various potential market scenarios. Portfolios may consist of positions in options, stocks, futures and options on futures based on the same underlying instrument or on different highly correlated underlying instruments. Option positions include equity, index and currency products.
OCC utilizes a proprietary derivation of the Cox-Ross-Rubinstein binomial option pricing model to calculate projected liquidating prices. Projected prices are calculated based upon the closing underlying asset price for each day plus and minus price moves at ten equidistant data points over a broad range of market movements:
For broker-dealers other than non-clearing specialists and/or market makers, the appropriate percentages of the daily market price of the underlying are +/-15% for equities, narrow-based indexes, and non-high capitalization diversified indexes, +/-10% for high capitalization diversified indexes, +/-6% for major market foreign currencies and +/-20% for all other currencies.
For non-clearing specialists and market makers, the percentages of the daily market price of the underlying are +6/-8% for high capitalization diversified indexes, +/-10% for non-high capitalization indexes and +/-4.5% for major market foreign currencies.
The implied volatility curve specific to an option's underlying security and maturity is matched to the potential market scenarios in the calculation of projected prices for that option. Interest rates reflect current swap rates, and dividend amounts are input as reported by an outside vendor. Prices for all instruments are projected, and the resulting profits and losses of the portfolio are summed to estimate the projected aggregate gain or loss at the underlying price move. Within a class group (all products with the same underlying instrument), 100% of a position's gain at any one valuation point is allowed to offset another position's loss at the same valuation point.
Other offsets are provided to instruments based on product groups and portfolio groups. Product groups are comprised of closely related broad-based indexes, sector indexes and currencies. Portfolio groups consist of closely related product groups. In the case of index options and related instruments offset by a qualified stock basket (as defined in Appendix A of the net capital rule), there will be a 95% offset with a minimum charge of 5% of the market value of the basket for high capitalization diversified and narrow-based indexes and 7.5% of the market value of the basket for non-high capitalization diversified indexes.
To account for liquidation risk, a minimum charge of 1/4 point per contract times the appropriate multiplier is applied when the class, product or portfolio group reflects little or no market exposure (or $25.00 per option contract assuming that option contract covers 100 shares). The largest projected loss for the entire class, or group in the case of the offset-eligible products, over the range of ten potential market scenarios is the required capital charge for this portfolio.
OCC computes and makes available theoretical profit and loss values for each option series and for the related and underlying instruments on a daily basis. Firms' open positions and the theoretical values can be combined to compute the appropriate capital charge.
OCC-cleared OTC options are eligible for RBH calculations. The product details and P&L arrays for these OTC options are only available in the FIXML version of the RBH/CPM Theoretical Output files and will be provided in a separate OTC Theoretical file. Also, the OTC Theoretical files will be proprietary such that subscribers will only receive an OTC Theoretical file with series information and P&L values of OCC-cleared OTC options in which they hold open positions. Further information about FIXML files can be found on the RBH Documentation page in the ENCORE DDS Guide - Risk Based Haircuts / Customer Portfolio Margining (RBH/CPM).
For additional information on obtaining theoretical profit and loss values from OCC, please send an inquiry to [email protected].
Risk Based Haircuts and Customer Portfolio Margin Documentation