CME SPAN Methodology Overview

The CME SPAN methodology evaluates overall portfolio risk by calculating the worst possible loss that a portfolio of derivative and physical instruments might reasonably incur over a specified time period (typically one trading day). This is done by computing the gains and losses the portfolio would incur under different market conditions.

At the core of the methodology is the CME SPAN risk array, a set of numeric values that indicate how a particular contract will gain or lose value under various conditions. Each condition is called a risk scenario. The numeric value for each risk scenario represents the gain or loss that particular contract will experience for a particular combination of price (or underlying price) change, volatility change, and decrease in time to expiration.

Exchanges and clearing organizations using the CME SPAN methodology will determine for themselves the following CME SPAN parameters, reflecting their desired degree of risk coverage:

• Price scan ranges (Scan risk) – the maximum price movement reasonably likely to occur for each instrument or, for options, their underlying instrument
• Volatility scan ranges – the maximum change reasonably likely to occur for the volatility of each option's underlying price
• Intra-commodity spreading parameters – rates and rules for evaluating risk among portfolios of closely related products, for example products with particular patterns of calendar spreads
• Inter-commodity spreading parameters – rates and rules for evaluating risk offsets between related products
• Delivery (spot) risk parameters – rates and rules for evaluating the increased risk of positions in physically-deliverable products as they approach or enter their delivery period
• Short option minimum parameters – rates and rules evaluating the irreducible minimum risk associated with portfolios of deep out-of-the-money short option positions.

At least once every business day, each exchange or clearing organization using the CME SPAN methodology calculates risk arrays for all of its products and prepares a CME SPAN risk parameter file (also called a CME SPAN array file) containing all of the above data. These files are then published to clearing firms and other market participants. Using these freely-available files and inexpensive software such as the CME PC-SPAN software, calculating performance bond requirements for portfolios is quick and easy.

The CME SPAN methodology divides the instruments in each portfolio into groupings called combined commodities. Each combined commodity represents all instruments on the same ultimate underlying – for example, all futures and all options ultimately related to the S&P 500 index.

For each combined commodity in the portfolio, the CME SPAN methodology evaluates the risk factors described above, and then takes the sum of the scan risk, the intra-commodity spread charge, and the delivery risk, before subtracting the inter-commodity spread credit. The CME SPAN methodology next compares the resulting value with the short option minimum; whichever value is larger is called the CME SPAN methodology risk requirement. The resulting values across the portfolio are then converted to a common currency and summed to yield the total risk for the portfolio.