Value at Risk showing historical analysis and figures

In the context of margining methodologies, a discussion has been ongoing regarding the comparison between SPAN and VaR approaches, revolving around the accuracy and effectiveness of these methodologies in capturing risk. Advocates of SPAN argue that it offers a more comprehensive assessment by considering various factors specific to individual contracts and portfolio interactions and believe that this approach provides a more accurate reflection of risk exposure. Meanwhile, proponents of VaR argue that it provides a simplified and transparent measure of risk, making it easier to understand and implement. VaR is widely used in financial institutions and offers a standardized framework for risk assessment.

The CME and ICE have taken a leadership position on this and are transitioning over to VaR at various points over the next 12 months. KRM22’s post trade functionality has always reflected the array based margins of these exchanges, a feature key to our customers. In response to the decisions made by the CME and ICE, KRM22 is updating our Trading Risk suite to more closely represent their account’s risk exposure. This will allow for the risk management communities to view their parameterized stress risk, margin requirement, and VaR calculations in the same view providing a wholistic risk profile associated to their accounts.

VaR calculations will include customizable confidence levels, expected shortfall, histogram, and product sector breakdown of each portfolio.

We are already working with the exchanges and customers to develop and test the new functionality. Traditional array based margining will continue to be supported as long as the exchanges make it available.

Contact us to discover more about migrating to historical VaR.

CME Span 2 Margin

The CME’s SPAN 2 margin methodology is going through testing and should begin to be implemented later this year.  The new margin methodology is not only a significant change to how margin is currently calculated but is being deployed as an “evolutionary” change rather than a “revolutionary” change.

The new margin rules are intended to co-exist with current SPAN margin methodology as opposed to replacing them. The current SPAN methodology has been highly effective for many years.  When SPAN 2 is put in place it means members of the exchange will have new set of margin calculations which incorporate more product correlations and historical data– not necessarily better or worse, but different.  

The reason for this is simple – different periods of volatility equate with different results under different margin methods.  The introduction of Historical risk views (hVaR) into SPAN 2 is just one major change to the existing SPAN model.  Yet hVaR may not always have enough of a time horizon to foresee anticipated price movements or “vol shocks”.   By leveraging multiple methods, the CME and its members will have a more “holistic” way to see an account’s true risk.  

These changes are not new to KRM22.  The combination of using an exchange’s internal margin methodology and combining those calculations with custom “stresses” and hVaR is the most fundamental aspect of KRM22’s market risk solution.  Our At Trade and Post Trade Stress system was first introduced in 2020 as a complete “end to end” product that combines the three major elements of SPAN 2 directly to our customers.  

We are currently working with the CME to ensure our independent margin calculations will be SPAN 2 compliant as well as provide direct access to the CME’s API-based SPAN 2 margin calculators.  

KRM22 has always been committed to bringing our customers the optionality of importing margin calculations directly from the exchanges they are members of as well as providing an independent valuation of their margin through our powerful margin calculation engine.  We look forward to continuing this level of service to our customers who rely on the CME to support clearing and trading activities throughout this introduction of SPAN 2.  

For more information on KRM22’s margin systems please contact Stephen Casner, President KRM22 (  or David Zurkowski, Director of Market Risk Products (

Holy Cow! Over the past 15 months we have seen remarkable events in the medical field, in nature, politics, sports and the trading markets. The headliners include Covid-19, vaccine development, brush fires, freezing temperatures in warm climates, warm temperatures in freezing climates, political and social unrest around the globe, impeachment proceedings, senior Royals stepping down, the cancelling of the Olympics, the death of Kobe Bryant, a stock market crash and rebound, negative commodity prices in Crude Oil and a powerful stock squeeze. So many unpredictable events impacting our lives and our mental states and how we will perceive the future. Not even the finest ‘Magic 8 Ball’ device could have forecasted these events.

There have always been, and will continue to be, unforeseen events that impact our behavior. However, we have no control over who, what, where, when and how these events appear. The same goes for the market; the risk that never leaves us is the unknown. The market listened and reacted to all the events listed above, but in differing magnitudes and intensities. Whether the reactions were rational/irrational, too big/too small, handled properly/poorly will be debated for a long time. The only certainty is that market reactions to newsworthy events will continue.

Managing the ‘event risk’ of known events like economic announcements, elections, crop reports, and energy supply data is a skill learned by looking at historical outcomes and outliers from prior announcements. Having industry experience in a particular sector is a great bonus. Applying market and correlation shocks that mirror past performance is a standard starting point for known events. In many cases, once the known event has passed, much of the uncertainty driving market behavior is temporarily removed and volatility is reduced. However, evaluating and managing the risks of unknown events involves some creativity. It is an art as much as it is science.

Two Scenarios (A and B) of unanticipated events and two different risk methodologies:

Short Term Spike Scenario

The takeaways: Violent Spike, Short-Term Impact and Certainty

A) The cold weather event in the Southern USA in February caught many people off guard. Electricity prices skyrocketed as temperatures dropped, demand rose exponentially, and the electricity grid became unstable. This created tremendous short-term uncertainty. But as unexpected and unfortunate as this was, this cold temperature pattern was not going to continue indefinitely. Weather forecasters pinpointed a return to normalcy relatively quickly.

Managing the risk to define the effects of this type of event involves applying extreme shocks to spot and front month prices (and related option volatilities and skews) while essentially leaving back month prices and volatilities static. It is wise to stress Implied option volatilities by a large multiple (2 to 5 times for example) of their current levels to expose ‘short-teeny’ risk (a position that is short out-of-the-money options). The weather event described is a ‘one and done’ occurrence and the practice of creating ‘front month’ price and volatility shock correlations for deliverable commodities should be a standard part of every risk manager’s tool kit. Even if the event you are trying to simulate/anticipate does not materialize for months or even years, it is critical to have the information available daily and assess the materiality of the outcome across an entire organization.

Long Term Uncertainty Scenario

The takeaways: Uncertainty, Safe vs. Risky and Breakdowns of ‘Normal’ Correlations

B) Using the Covid-19 pandemic as an example, most alive today never lived through a global pandemic. How long will it last? How contagious is it? Who is most at risk? Is there a cure? The emergence of Covid-19 as a global pandemic was slow and steady. There was conflicting information in the medical community about the cause and severity. Financial markets do not like uncertainty and as such, equity prices plummeted in March 2020 as the World Health Organization (WHO) announced a global emergency. Many countries followed the WHO announcement with travel bans put in place to stop the spread of the virus between countries. With tight restrictions in place for daily activities, industries like airlines, hospitality, entertainment, restaurant, energy, automotive, manufacturing and sports were all hit very hard. Unlike the weather example above, the was no clear guidance on how long we would be dealing with this issue (it is ongoing today). Unlike the “one and done” weather example above, the Covid-19 event has financial implications over a much longer term. How does a risk manager prepare for an event for which we have no reference data? We will explain potential scenarios to have at the ready.

Managing the risk to anticipate a scenario where industries and societies are slowed indefinitely demands some creative thinking. Some assumptions may assist in our process. Governments around the world will most likely seek to lessen the impacts of the event by providing liquidity (i.e., lower interest rates). Investors will look for some certainty by moving from riskier assets to less risky instruments (think of a ‘flight to quality’ toward government bonds, gold and silver and away from stocks for example). The yield or growth on investments will be less important than preservation of capital. ‘Safe’ assets will appreciate, and ‘risky’ instruments will depreciate. ‘Normal’ or ‘historical’ correlations across the yield curve and futures price curves breakdown. Unlike the weather example, the asset price movements affect tradeable assets 1 year, 2 years and even 3+ years into the future as there is no clear end to the societal disruption. Stock sectors like energy, transportation will suffer as daily demand for travel and daily commuting is reduced, while sectors providing services to help remedy the situation will expand.

A stress scenario that will provide a view into potential outcomes for this type of event applies equivalent price/yield movements (the same percentage or absolute price/yield shock across every expiration month of a product) to simulate real world market reaction. For example, applying the same basis point shock to all interest rate instruments on the yield curve will give a view into the P&L implications of a ‘flight to quality’. This estimate will not be perfect, but it will expose strengths or weaknesses of positions. Similarly, using the same absolute price shock and volatility change to all gold contract expirations is a starting point. On the negative price side, all stock sectors can be shocked by the same percentage move regardless of country, sector or market cap.

Shocking all months of Crude Oil or Copper in the same magnitude will expose weaknesses that would not appear under standard correlated stressing scenarios. For option positions, shocking the skew (the relationship between put and call volatilities) and the At-the-Money volatility in the same manner across multiple product expirations exposes the risk of a change in market sentiment. Products that traditionally had ‘bullish’ skew prior to the long-term disruption may now have a completely ‘bearish’ skew (and vice-versa). The P&L and Greeks associated with this change can be enormous. Adding the calculation of ‘extreme’ price and volatility shocks is also a necessary tool in the event of a ‘once in a lifetime’ occurrence (shocking prices by 10 -15 Sdev moves, whoa!.. but think about the explosive movement of Crypto Currencies and Game Stop stock over the past 15 months!)

Creating market stress scenarios to address the situations above should be normal operating procedure to identify weaknesses in trading positions. The goal is to expose risks not seen when using only current or historical price moves and correlations. While none of us has a crystal ball to predict future events, being prepared and having advance knowledge of potential financial outcomes prior to an unscheduled event is the key. The creative use of combinations of price curve stress, correlation breakdowns and volatility shocks allow a risk manager to “always expect the unexpected”.

While interest rates remain steady, change in Washington often means change in perspective and direction. If the stimulus bill is passed, what happens if the market starts to feel interest rate pressure again? Let’s look back to the a recent interest rate market event and how risk managers were able to react to it.  

The two months of June and July of 2019 brought unforeseen volatility into the interest rate arena. During this period, the Federal Reserve did an ‘about face’, regarding the direction of interest rates in the US. This came as an unwelcome surprise to market participants as most traders, speculators and hedgers were prepared for a rising or unchanged interest rate environment, with very little attention paid to the thought of declining interest rates. This group- think caused a ‘rush to exits’ to reverse or close out existing positions.  

Market risk managers are tasked with evaluating and diffusing these situations on a daily basis. A proactive risk manager will attempt to determine the outcome of potential events before they occur. They view the risk outside the ‘groupthink’ box and consider what happens if the market behaves in a manner 180 degrees removed from the consensus expectation.

The tools used to expose and mitigate these events are often known as ‘what if’ stressing scenarios. This practice allows risk managers to view the outcome of yield curve shifts and then determine if the risk exceeds the benefit of holding the position. Traders are famous for advocating on behalf of their positions and for stating “that won’t happen” when a risk manager poses an assumption that impact the trader’s position. However, it is imperative the risk manager know the answer to the question “what if it does happen?” prior to the event.

Market participants have an aggregate idea of the potential outcome when the market behaves ‘normally’. The key goal of risk management is to identify the outliers to ‘normal’ and then determine if the risk taken is warranted based on the probability of a ‘non-normal’ outcome.

Identifying the Negative Outcomes

Using post-trade stressing tools, risk managers create ‘what if’ scenarios to determine the potential profit/loss of: a steepening/flattening of the yield curve during rising/declining rate environments, an inverted yield curve during a rising/declining rate environment, a spike/dip in short-term rates due to a geopolitical event and/or eroding liquidity levels, but to name a few. These scenarios may be contrary to the current market wisdom at any point in time, but they must be evaluated daily as the associated risk needs to be identified before the ‘non-normal’ events are set in motion.

The examples given above pertain to positions containing only underlying securities. What happens if options are added to these positions or if these positions/strategies are created entirely out of options? This would introduce entirely new categories of risk and would require the risk manager to consider the following:

  • Shocking relative volatility levels of contracts in a particular segment of the yield curve (all of the monthly contracts of the 10yr T-note, for example), as well as across the entire yield curve (30yr,10yr, 5yr, 2yr, Eurodollars, Fed Funds)
  • Shocking volatility shapes (skew) on each piece of the yield curve as well as across the entire yield curve.
  • Calculating the theta of holding these positions each day and evaluating the effect of option expiration dates on the option behavior (for example, does this option expire before the upcoming Fed Meeting but others do not?).

The complexity of managing multi-dimensional risk (price/time/volatility/skew) calls for robust ‘what if’ tools that can simulate potential market events. These risks are real and should be evaluated as often as the ‘normal’ market expectation. Without the proper tools at his/her disposal, the risk manager is essentially driving while wearing a blindfold.