Minimum Capital Requirements for Market Risk

In addition to the above capital requirements arising from delta risk, there are further capital requirements for gamma and vega risk. Banks using the delta-plus method will be required to calculate the gamma and vega for each option position (including hedge positions) separately. The capital requirements should be calculated in the following way: (1) For each individual option a gamma impact should be calculated according to a Taylor series expansion as follows, where VU is the variation of the underlying of the option. (2) VU is calculated as follows: (a) For interest rate options if the underlying is a bond, the market value of the underlying should be multiplied by the risk weights set out in [14.26] . An equivalent calculation should be carried out where the underlying is an interest rate, again based on the assumed changes in the corresponding yield in [14.26] . (b) For options on equities and equity indices: the market value of the underlying should be multiplied by 8%. 89 (c) For FX and gold options: the market value of the underlying should be multiplied by 8%. (d) For options on commodities: the market value of the underlying should be multiplied by 15%. (3) For the purpose of this calculation the following positions should be treated as the same underlying: (a) for interest rates, 90 each time band as set out in [paragraph 718(iv) / [14.26] ; 91 (b) for equities and stock indices, each national market; (c) for foreign currencies and gold, each currency pair and gold; and (d) for commodities, each individual commodity as defined in [14.67] . (4) Each option on the same underlying will have a gamma impact that is either positive or negative. These individual gamma impacts will be summed, resulting in a net gamma impact for each underlying that is either positive or negative. Only those net gamma impacts that are negative will be included in the capital requirement calculation. (5) The total gamma risk capital requirement will be the sum of the absolute value of the net negative gamma impacts as calculated above. (6) For volatility risk, banks will be required to calculate the capital requirements by multiplying the sum of the vega risks for all options on the same underlying, as defined above, by a proportional shift in volatility of ± 25%. (7) The total capital requirement for vega risk will be the sum of the absolute value of the individual capital requirements that have been calculated for vega risk. Scenario approach 14.81 More sophisticated banks may opt to base the market risk capital requirement for options portfolios and associated hedging positions on scenario matrix analysis. This will be accomplished by specifying a fixed range of changes in the option portfolio’s risk factors and calculating changes in the value of the option portfolio at various points along this grid. For the purpose of calculating the capital requirement, the bank will revalue the option portfolio using matrices for simultaneous changes in the option’s underlying rate or price and in the volatility of that rate or price. A different matrix will be set up for each individual underlying as defined in [14.80] above. As an alternative, at the discretion of SAMA, banks that are significant traders in options will for interest rate options be permitted to base the calculation on a minimum of six sets of time bands. When using this method, not more than three of the time bands as defined in [14.26] and [14.29] should be combined into any one set.