Safer Margins for Option Trading: How Accuracy Promotes Efficiency

Rafi Eldor (), Shmuel Hauser and Uzi Yaari
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Rafi Eldor: Interdisciplinary Center, Israel
Shmuel Hauser: Ono Acdemic College and Ben-Gurion University, Israel
Uzi Yaari: Rutgers University, USA

Multinational Finance Journal, 2011, vol. 15, issue 3-4, 217-234

Abstract: Margin requirements are designed to control the default risk inherent to commitments undertaken by traders writing options. Much like similar institutions, the Tel Aviv Stock Exchange first adopted a system based on the Standard Portfolio Analysis of Risk (SPAN), which sets required levels of options margin according to the most pessimistic of 16 possible outcomes. Seeking to lower the probability of default without adversely affecting liquidity, the Exchange switched in 2001 to a more detailed margin system based on the most pessimistic of 44 scenarios. This unique change provides an ideal laboratory for testing the impact of increased margining precision on the efficiency of option trading. Based on a sample of over 3 million transactions, this study demonstrates that the more accurate pricing of default risk over the studied range increases efficiency by a number of measures, including a smaller implied standard deviation and deviations from put-call parity.

Keywords: option margins; option default risk; market efficiency; SPAN system (search for similar items in EconPapers)
JEL-codes: G11 G13 G14 G20 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (1)

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