SPAN:

The First
20 Years
By David Adam

Happy anniversary! With little fanfare the CME Group is celebrat-

ing the 20th anniversary of the launch of Standard Portfolio
Analysis of Risk, or SPAN—a methodology for evaluating risk and
calculating margin requirements that revolutionized futures and
options risk management when it was introduced and today
serves as an industry standard around the world.

Over 20 years ago, Rick Kilcollin and
David Emanuel, chief economist and senior
economist in the CME research department,
respectively, at the time, saw the need to
apply the same risk management approach to
options that CME had successfully applied to
futures. Options trading was growing rapidly,
but methods for calculating margin require-
ments in use at the time did not do a good job
of accurately capturing the true risk for com-
bined portfolios of futures and options. That
was a problem either way. If requirements
were too low, they wouldn’t protect the clear-
ing organization and the clearing firm from
risk of default. If too high, they would use
capital inefficiently. Kilcollin and Emanuel
proposed a true risk-based method for evalu-
ating a portfolio’s performance bond require-
ments. They had captured the concept, but
their proposal was too complicated for the
bookkeeping services in the mid-1980s.
Jerry Roberts, a CME economist, was
tasked with strengthening and simplifying
this risk-based method and making it accept-
able to the industry’s back offices. He divided
the process into two parts: the option pricing
calculations with their complex math, and
the portfolio risk calculations with their basic
arithmetic. The exchange or clearing organ-
ization would do the option pricing, and
package results into a file called the SPAN
risk parameter file, also often referred to sim-
ply as the SPAN file. The SPAN file would
be freely distributed to clearing firms and the
broader community of market participants.
The clearing firms and their bookkeeping
services could then apply the data in the
SPAN file to the portfolio of positions held
in individual accounts using simpler pro-
grams and more understandable processes.
This innovation gave the system the flexibil-
ity it needed to deliver powerful risk manage-
ment in a customer-friendly package.
CME then created a cross-functional
team to build the new system and sell the
industry on its merits. Kate Meyer, a key
member of the Clearing Division manage-
ment team, led the charge, and Ed Gogol,
software developer, Clearing Division, devel-
oped the original version of the PC program
that proved critical to success. CME rolled
SPAN out for calculating performance bond
requirements for CME clearing firms on Dec.
16, 1988. “It was a big job,” recalls Gogol,

32 Futures Industry
now managing director, clearing solutions,
“and truly an example of teamwork between
design, development, and operations. And if
we hadn’t listened to our customers and
incorporated their feedback, we would have
failed.” Roberts agrees: “The industry
accepted the concept, but they loved the
responsiveness and customer support.”
“When we first developed SPAN, it was
for our own use,” says Gogol. “But other mar-
kets had the same need, so it was natural for
us to provide SPAN to other exchanges and
clearing organizations.” Working through
the Joint Audit Committee, SPAN was
adopted over the next few years by all North
American futures markets. From there,
SPAN spread to global financial capitals
including London, Paris, Tokyo, Osaka,
Singapore, Hong Kong, Sydney and many
others. Over the years, SPAN has been
adopted by more than 50 exchanges and
clearing organizations.
CME points to several reasons for
SPAN’s widespread adoption: (1) the
methodology itself, in particular its power
and flexibility, (2) the ease with which
SPAN could be implemented, (3) the bene-
fits of standardization, and (4) the software
for SPAN which CME has made available.
The SPAN Methodology
Like all methodologies that are part of
the of the Value-at-Risk (VAR) family, it’s
not really meaningful to ask whether margin
requirements calculated by SPAN are higher
or lower than those calculated by other
methods. The results provided by SPAN are
crucially affected by the inputs provided to
the methodology, and in particular the
desired degree of risk coverage. The most
important point about SPAN is that, given a
particular desired degree of risk coverage, it
will do a better job of targeting the margin
requirement to the actual risk of the portfo-
lio than methodologies which are not portfo-
lio-approach based and risk-based.
For example, CME typically sets SPAN
inputs to cover the maximum likely one-day
loss to at least a 95% confidence level, and in
most cases to a 99% confidence level. Other
markets might set the inputs to cover risk to
a different confidence level, and some SPAN
users seek to cover the maximum loss over a
two-day or a three-day “look-ahead” period.
Besides the number of days ahead for
which risk is being evaluated, the key inputs
to SPAN, for each product, are parameters
which specify how much the price might
change over the desired period, and how
much the volatility of that price might vary.
For options, these parameters are specified for The data contained in the SPAN file is
the underlying instrument. Then, using par- then applied to particular portfolios—for
ticular combinations of changes in underlying example, a daily calculation for each cus-
price and volatility of underlying price, tomer account by a clearing firm. The portfo-
SPAN performs a series of simulations to lio is divided into parts, called “combined
determine how each particular tradeable commodities”, each of which contains all of
instrument might gain or lose value over a the instruments related to the same ultimate
specified time in the future. The set of scenar- underlying—for example, all futures and
ios which is evaluated for each instrument is options related to the S&P 500 index would
called the risk scenario set, and the results of comprise a single combined commodity. For
the simulations—a series of simple monetary each combined commodity, the following
gains and losses—are called the risk arrays. steps are then performed:
The risk arrays for every contract are • Evaluating the scan risk, in which the data
packaged into the daily SPAN risk parameter contained in the risk arrays is applied to
file, which can be thought of as: a machine- the individual positions, to determine the
readable database of eligible contracts; their maximum likely loss for that particular
daily settlement prices and other product group of positions;
information; SPAN risk arrays; and all other • Evaluating the calendar spread risk, which
parameters needed by SPAN to calculate tailors additional charges to particular pat-
margin requirements. Produced at least once terns of positions which may exist across par-
per day by every exchange or clearing organ- ticular contract months within the product;
ization using SPAN, the SPAN file is then • Evaluating the delivery risk, which recog-
distributed freely to market participants. nizes special risks which may be associated
with positions in physically-deliverable
STANS: OCC’s Model for
Calculating Margin Requirements
In 1986, The Options Clearing Corporation developed and distributed Theoretical Intermarket
Margining System, the first portfolio margin system used at a clearinghouse. TIMS, an algorithm for
calculating portfolio margins and facilitating risk management, addressed shortcomings of the strat-
egy-based method by determining the maximum loss associated with an entire portfolio of positions
given a percentage move in the underlying assets.TIMS is widely used today by derivative exchanges
and clearing houses for calculating risk-based haircuts and customer portfolio margins.
More recently, the OCC developed a proprietary risk margining system based on a more mod-
ern approach to measuring risk. This new approach, which requires more sophisticated statistical
methods, more complex calculations, and greater computing power than TIMS, addresses certain
shortcomings of the TIMS model, particularly with respect to correlations in price movements and
the modeling of extreme events. Implemented in August 2006, System for Theoretical Analysis and
Numerical Simulations (STANS) generates a set of 10,000 hypothetical market scenarios that
incorporate information extracted from the historical behavior of each individual security as well
as its relationship to the behavior of other securities. Scenarios are generated for more than 7,000
risk factors, including a broad range of individual equities, exchange-traded funds, stock indices,
currencies and commodity products.
Although the OCC continues to use TIMS for several risk management functions, it relies on
STANS for the critically important purpose of assessing clearing member margin requirements.
According to the OCC, the STANS model provides margin calculations that are more precise, more
realistic, and more consistent across portfolios, which should improve the financial stability of the
derivatives markets and produce capital efficiencies beneficial to investors.
The OCC is the world’s largest equity derivatives clearing organization. Last year the OCC
cleared 2.872 billion options and futures contracts and handled $1.3 trillion in option premiums.
Participant exchanges include: American Stock Exchange, Boston Options Exchange, Chicago
Board Options Exchange, International Securities Exchange, NYSE Arca Options, and Philadelphia
Stock Exchange. The OCC also serves other markets, including those trading commodity futures,
commodity options, and security futures, such as CBOE Futures Exchange, OneChicago and
Philadelphia Board of Trade.—David Adam
March/April 2008 33
 products as they approach or go into their
delivery process; and
• Evaluating the intercommodity spread
credit, which recognizes reductions in risk
associated with offsetting positions in dif-
ferent products.
The sum of these risk components
becomes the SPAN risk requirement for the
combined commodity, except that the value is
floored at the short option minimum amount,
a special process which recognizes risk for deep
out-of-the-money short option positions. The
SPAN risk requirements for the different com-
bined commodities are then converted to a
common currency and summed to yield the
total requirement for the portfolio.
As a methodology, SPAN is applicable to a
very wide spectrum of derivative and physical
product types. Over the years, SPAN has been
extended, generalized, and made very power-
ful. “We’re now on the fourth generation of the
SPAN methodology—we call it SPAN 4,” says
Gogol, “and we’re working on SPAN 5.”
SPAN is also particularly well-suited for
use in clearing linkages which can reduce
margin requirements, such as inter-exchange
spreading or formal cross-margin agreements.
CME has cross-margin agreements in place
with the Options Clearing Corporation,
Nymex Clearing, LCH.Clearnet and the
Fixed Income Clearing Corp. Another
SPAN feature worthy of special mention is
the ability to recognize the higher risk of
markets where positions are concentrated in
a relatively small number of market partici-
pants—something which CME does as part
of every daily settlement cycle.
Ease of Adoption,
and SPAN Software
Besides its characteristics as a methodol-
ogy, two factors driving the worldwide adop-
tion of SPAN have been the ease with which
an exchange or clearing organization can
implement it, and the software which CME
makes available for SPAN.
As a machine-readable database of product
information, settlement prices, and margin
rates and rules, the daily SPAN file produced
by each SPAN-using exchange and clearing

Scanning a Sample Portfolio

Here is an example of how the Span methodology works in practice. The following 16 scenarios are based on a simple port-
folio of two related positions: one long June 04 Euro FX futures contract and one short June 04 call option on the June 04 Euro
FX futures with a 1.150 strike. Assume that the settlement price on the futures contract was 1.1960, that the futures price scan
range was $2400, equivalent to 192 points, and that the volatility scan range was 1%. Based on these inputs, the system then
evaluates the “scan risk,” which represents the maximum likely loss for this portfolio under various market conditions.

One Short
One Long June on June 04
June 04 1.150 Call
# EuroFX EuroFX Option Portfolio Scenario Description
1 $0 - $130 - $130 Price unchanged; Volatility up the Scan Range
2 $0 $155 $155 Price unchanged; Volatility down the Scan Range
3 $800 - $785 $15 Price up 1/3 the Price Scan Range; Volatility up the Scan Range
4 $800 - $531 $269 Price up 1/3 the Price Scan Range; Volatility down the Scan Range
5 - $800 $500 - $300 Price down 1/3 the Price Scan Range; Volatility up the Scan Range
6 - $800 $815 $15 Price down 1/3 the Price Scan Range; Volatility down the Scan Range
7 $1600 - $1463 $137 Price up 2/3 the Price Scan Range; Volatility up the Scan Range
8 $1600 - $1240 $360 Price up 2/3 the Price Scan Range; Volatility down the Scan Range
9 - $1600 $1102 - $498 Price down 2/3 the Price Scan Range; Volatility up the Scan Range
10 - $1600 $1446 - $154 Price down 2/3 the Price Scan Range; Volatility down the Scan Range
11 $2400 - $2160 $240 Price up 3/3 the Price Scan Range; Volatility up the Scan Range
12 $2400 - $1967 $433 Price up 3/3 the Price Scan Range; Volatility down the Scan Range
13 - $2400 $1674 - $726 Price down 3/3 the the Price Scan Range; Volatility up the Scan Range
14 - $2400 $2043 - $357 Price down 3/3 the Price Scan Range; Volatility down the Scan Range
15 $2304 - $2112 $192 Price up extreme (3 times the Price Scan Range) – Cover 32% of loss
16 - $2304 $1466 - $838 Price down extreme (3 times the Price Scan Range) – Cover 32% of loss

In the sample portfolio above, in scenario 8, the gain on one long June 04 EC futures position offsets the loss of one short
EC June/June 04 1.150 call option position, incurring a gain of $360.
In scenario 16, the portfolio would incur a loss of $838 over the next trading day, which is 32% of the resulting loss if the
price of the underlying future decreases by three times the price scan range.
After SPAN has scanned the different scenarios of underlying market price and volatility changes, it selects the largest loss
among these observations. This “largest reasonable loss” is the scan risk charge. In this example, the largest loss across all
16 scenarios is a result of scenario 16, a loss of $838.

34 Futures Industry
organization becomes an invaluable tool for
market participants. As the developer of the
SPAN methodology, CME makes available to
the public, without charge, daily SPAN files
for most SPAN-using exchanges and clearing
organization; in fact, for any SPAN-using
exchange or clearing organization that cares to
transmit their files to CME. “People really look
to these files for risk management and other
purposes,” says Gogol. “We get calls from
around the world when somebody’s SPAN file
is late getting to our FTP site.”
CME makes available three software
products for SPAN: PC-SPAN, SPAN Risk
Manager, and SPAN Risk Manager Clearing,
each of which builds upon the capabilities of
the others:
• PC-SPAN loads SPAN risk parameter
files, allows users to define portfolios, and
calculate SPAN performance bond
requirements. Users can then produce a
wide variety of reports, and/or export
results to other processes. The most typical
use for PC-SPAN is by a market partici-
pant wishing to verify the performance
bond requirements their clearing firm is
charging, or to evaluate what the SPAN
requirement for a particular portfolio will
be. Auditors and regulators also make wide
use of the program.
• SPAN Risk Manager provides generalized
risk management capabilities. A variety of
option pricing calculations can be per-
formed, portfolio “greeks” can be evalu-
ated, and what-if scenarios can be defined
and applied.
• SPAN Risk Manager Clearing provides a
turn-key implementation of SPAN for use
by exchanges and clearing organizations.
All three products run in the Microsoft
environment, either on workstations or
servers, and can be operated in any of three
modes: (1) a point-and-click graphical user
interface; (2) using a script language, which
makes it easy to automate routine processing
tasks; and (3) using the “real-time compo-
nent interface”, which allows the SPAN soft-
ware to be driven in a high-speed manner
suitable for real-time risk-based pre-execu-
tion credit controls.
“This is the same software we use our-
selves,” says Gogol, “both for calculating
performance bond requirements for our
clearing firms, and for a wide variety of asso-
ciated risk management processes such as
stress testing.”
The Future of SPAN
CME says that it is working on SPAN
5—the next generation of the SPAN
methodology. “In 1988, SPAN represented a
balance between theoretical perfection, on
the one hand, and keeping things simple to
program and easy to understand on the
other,” says Gogol. “But today, computers are
many times more powerful. And the com-
plexity of the derivatives that we have to
process keeps increasing.”
The next generation of SPAN is
expected to include increasing the sophisti-
cation of recognizing risk offsets between
related products, incorporating the effect of
volatility changes on a more dynamic basis,
and adding special processing for more com-
plex options, such as digitals and barriers.
CME is not committing to a detailed time-
frame for SPAN 5. “We’re acutely sensitive
to the magnitude of the investment that
clearing firms and software providers have
made in building and enhancing SPAN,”
says Gogol. “We’re committed to maintain-
ing SPAN’s high degree of customer friendli-
ness and ease of implementation.” ■
David Adam is a consultant and freelance writer
based in Chicago with 20 years experience in com-
modity futures and options clearing/settlement oper-
ations and client services with multiple market users
and providers including exchanges, institutional
futures brokers, and proprietary trading groups.
March/April 2008 35