Serving the Quantitative Finance Community

 
User avatar
schizoidman
Topic Author
Posts: 2
Joined: September 21st, 2005, 7:17 pm

Mark-to-market of a CDS

December 31st, 2010, 6:18 pm

If I am a buyer of protection, what happens if the contract swings out of the money, i.e. the par spread tightens significantly from the point at which the trade was struck? Would I be required to post collateral in addition to paying the quarterly coupon?Or do the collateral posting rules apply to only the protection seller?Thanks,Schiz
 
User avatar
friesenjung
Posts: 1
Joined: March 29th, 2005, 10:47 am

Mark-to-market of a CDS

January 6th, 2011, 12:50 pm

why should you be obliged to post collateral? you are paying a fixed rate, if the spread tightens or widens doesn't matter. in case of a credit event you receive the short protection leg of payments. The only counterparty risk for the protection seller is that you can't pay the upfront agreed price of protection, and he should have made sure about that before entering the contract.Long answer short: no.
 
User avatar
daveangel
Posts: 5
Joined: October 20th, 2003, 4:05 pm

Mark-to-market of a CDS

January 6th, 2011, 12:58 pm

there are some people on this forum who believe that you can get a margin call for a full paid up option ...I am still struggling with that.
knowledge comes, wisdom lingers
 
User avatar
prodiptag
Posts: 0
Joined: September 12th, 2008, 4:41 pm

Mark-to-market of a CDS

January 6th, 2011, 2:05 pm

yep, I think you need to post collateral, if you are a csa counterparty. why? because under csa, there is nothing called fully paid up option otc. if you buy an option from your counterparty, and up in MTM on day1 and pay up the full premium, it is like extending a loan to your countrparty. In old days, folks were okay with that, these days not so much. So the counterparty post you back the ~premium (depending upon thereshold etc etc) in collaterals. So if we are dealing with csa counterparties, irrespective of who is the buyer or seller, if there is any MTM movement, one has to post collaterals to the othersfor the case of CDS, it is not even fully paid up, it is a linear instrument on the spread, no? so more so reasons to ask for colalterals. Example: you run a coutnerparty risks that she might not pay in case of default of reference, she runs the risk that you can stop the running premiums in between. of course you understand the 1st part why she needs to post you collaterals if the spreads widens and you are the buyer. the 2nd part you can understand like this, most probably your counterparty has put up a hedge. So since the spread moved against you (say from 500bps to 50bps), you stopped paying. So she has to get out of this hedge too, and someone has to insure she doesnt loose on that process, that's the collateral for, from your side. making sense? at ground level from the trader's point of view, it is simple, you have to post collaterals, cause if she is hedged, her hedge counterparty would demand it (through treasury desk , and if not, her treasury desk would demand it anyways, and she will always be charged the funding in any case
Last edited by prodiptag on January 5th, 2011, 11:00 pm, edited 1 time in total.
 
User avatar
daveangel
Posts: 5
Joined: October 20th, 2003, 4:05 pm

Mark-to-market of a CDS

January 6th, 2011, 2:16 pm

Quote yep, I think you need to post collateral, if you are a csa counterparty. why? because under csa, there is nothing called fully paid up option otc. if you buy an option from your counterparty, and up in MTM on day1 and pay up the full premium, it is like extending a loan to your countrparty. [but this is not the same as someone who just buys an option. if I am a buyside investor and just buy puts on an exchange you think I will get a margin call ? Come on... And anyway, in the example you have cited let sya on day one the option premium and csa are exact so the buyer pays the seller the premium and the seller promptly returns the premium as margin to the buyer. if the option goes against the buyer then he pays back some of the margin he has received which to me is not a margin call but a return of margin. if the option value goes to zero, the most the buyer would have to post would be all of the collateral ie premium he recieved on day 1 which he should have paid anyway.
Last edited by daveangel on January 5th, 2011, 11:00 pm, edited 1 time in total.
knowledge comes, wisdom lingers
 
User avatar
prodiptag
Posts: 0
Joined: September 12th, 2008, 4:41 pm

Mark-to-market of a CDS

January 6th, 2011, 3:03 pm

@daveangel: yep, if you just buy an option on exchange, and pay the premium (i.e. no margining), then of course no margin calls possible, same happens even if you buy option otc and you are not a csa party and pay up the full premium upfront (and receive no collaterals) - no margin call. but things change when you have a csa (2-way to be precise and depends on finer prints of the agreements too). Also some exchange uses futures like margining for options too (no cash on day 1 from either party), so there again you have no "fully paid up premium" and you can get a "margin call" on long positionand yes, in this case you actually just post back the collaterals you received on day1. so you may call it a "return of margin", you will never post back more than you received on day1. but imagine someone running a large book with all sorts of long and short positions, it is impossible to map the "margin calls" to "real margin call" and "return of margin", end of the day the effect is same, your treasury calculate the net shortfall, post the margins (or receives) and slap you the funding. if you have the time (and need the comfort of knowing) how much of it is "return of margin", of course you can do that, but for most people I know, it doesnt matter and so they simply do not care
 
User avatar
daveangel
Posts: 5
Joined: October 20th, 2003, 4:05 pm

Mark-to-market of a CDS

January 6th, 2011, 3:07 pm

QuoteOriginally posted by: prodiptag@daveangel: yep, if you just buy an option on exchange, and pay the premium (i.e. no margining), then of course no margin calls possible, same happens even if you buy option otc and you are not a csa party and pay up the full premium upfront (and receive no collaterals) - no margin call. but things change when you have a csa (2-way to be precise and depends on finer prints of the agreements too). Also some exchange uses futures like margining for options too (no cash on day 1 from either party), so there again you have no "fully paid up premium" and you can get a "margin call" on long positionand yes, in this case you actually just post back the collaterals you received on day1. so you may call it a "return of margin", you will never post back more than you received on day1. but imagine someone running a large book with all sorts of long and short positions, it is impossible to map the "margin calls" to "real margin call" and "return of margin", end of the day the effect is same, your treasury calculate the net shortfall, post the margins (or receives) and slap you the funding. if you have the time (and need the comfort of knowing) how much of it is "return of margin", of course you can do that, but for most people I know, it doesnt matter and so they simply do not careyour second point is understood. and I think we are singing off the same hymn sheet.
knowledge comes, wisdom lingers