Minimum Capital Requirements for Market Risk

In the simplified approach for options, the positions for the options and the associated underlying, cash or forward, are not subject to the standardised methodology but rather are carved-out and subject to separately calculated capital requirements that incorporate both general market risk and specific risk. The risk numbers thus generated are then added to the capital requirements for the relevant category, ie interest rate related instruments, equities, FX and commodities as described in [14.3] to [14.73] . The delta-plus method uses the sensitivity parameters or Greek letters associated with options to measure their market risk and capital requirements. Under this method, the delta-equivalent position of each option becomes part of the simplified standardised approach set out in [14.3] to [14.73] with the delta- equivalent amount subject to the applicable general market risk charges. Separate capital requirements are then applied to the gamma and vega risks of the option positions. The scenario approach uses simulation techniques to calculate changes in the value of an options portfolio for changes in the level and volatility of its associated underlyings. Under this approach, the general market risk charge is determined by the scenario grid (ie the specified combination of underlying and volatility changes) that produces the largest loss. For the delta-plus method and the scenario approach, the specific risk capital requirements are determined separately by multiplying the delta-equivalent of each option by the specific risk weights set out in [14.3] to [14.52] . Simplified approach 14.76 Banks that handle a limited range of purchased options can use the simplified approach set out in Table 11 for particular trades. As an example of how the calculation would work, if a holder of 100 shares currently valued at USD 10 each holds an equivalent put option with a strike price of USD 11, the capital requirement would be: USD 1,000 x 16% (ie 8% specific plus 8% general market risk) = USD 160, less the amount the option is in the money (USD 11 - USD 10) x 100 = USD 100, ie the capital requirement would be USD 60. A similar methodology applies for options whose underlying is a foreign currency, an interest rate related instrument or a commodity. Simplified approach: capital requirements Table 11 Position Treatment Long cash and long put or short cash and long call The capital requirement will be the market value of the underlying security 82 multiplied by the sum of specific and general market risk charges 83 for the underlying less the amount the option is in the money (if any) bounded at zero 84 Long call or long put The capital requirement will be the lesser of: (i) the market value of the underlying security multiplied by the sum of specific and general market risk charges 82 for the underlying and (ii) the market value of the option 85 Delta-plus method 14.77 Banks that write options will be allowed to include delta-weighted options positions within the simplified standardised approach set out in [14.3] to [14.73] . Such options should be reported as a position equal to the market value of the underlying multiplied by the delta. However, since delta does not sufficiently cover the risks associated with options positions, banks will also be required to measure gamma (which measures the rate of change of delta) and vega (which measures the sensitivity of the value of an option with respect to a change in volatility) sensitivities in order to calculate the total capital requirement. These sensitivities will be calculated according to an approved exchange model or to the bank’s proprietary options pricing model subject to oversight by SAMA. 86