Bitcoin Option Collateral Netting

The collateral netting procedure described below is used whenever a potential change to a Participant’s portfolio of Bitcoin Range Binary Options is evaluated. 

This net outcomes procedure is scoped to binary option contracts listed for mutually exclusive ranges 1) settling against the same underlying index, and 2) expiring at the same time.  No collateral netting occurs on positions settling to different indices and expiring at the same time, or on positions settling against the same index but expiring at different times, or on positions settling against different indices and expiring at different times.  

When a Participant enters into their first position, their available balance is debited and the Clearinghouse pool account is credited as a collateralizing action.  Notwithstanding trading fees, individual short positions in an expiration require ($10-trade price)*trade size to collateralize, and individual long positions in an expiration require trade price*trade size to collateralize.

Prior to accepting a limit order, MIAXdx will evaluate available Participant collateral to ensure it is sufficient to support the order, but MIAXdx does not lock Participant collateral until a trade is executed.  

As Participants enter, or attempt to enter, a subsequent position settling against the same index and expiring at the same time, their marginal collateral requirements are evaluated on a trade-by-trade basis by determining the change in their portfolio’s worst case outcomes, or maximum loss, if the new position is added to their existing positions.

1. The Participant’s new position size is calculated assuming the new trade takes place.
2. The Participant’s net payouts at settlement in light of the new position are calculated assuming each range in the expiration may be the winning range (each, a net outcome) by: 1) increasing the net payouts in the contract range that is changing position size by the net_to_win amount, and 2) for all other ranges, increasing the net payouts by the net_to_lose amount.
   • Net_to_win is the signed (+/-) position change multiplied by the $10 binary payout minus the trade price (position_change*(binary_payout - trade_price)) and net_to_lose is the negative of the signed position change multiplied by the trade price (-1*position_change*trade_price).
   • This step increases the net payouts by net_to_win in the range that is changing position, and not by the full binary payout amount, because if that range was the winning range, the collateral to support that new position would be returned to the participant at settlement if the position change was positive, and if another range was the winning range the participant would owe the net_to_lose amount to a different participant at settlement. The reverse interpretation for the net_to_win and net_to_lose amounts applies if the position change was negative. 
3. Guaranteed profit and loss on the new portfolio of positions is then calculated, and in the case of guaranteed profit (loss), resolved by crediting (debiting) the Participant’s available balance accordingly and debiting (crediting) the Clearinghouse pool account by the amount of the profit (loss). If there is guaranteed profit or loss, the Participant’s net payouts are also updated as follows:
   • Guaranteed profit is defined as when the minimum net payout is positive across scenarios where any range may be the winning range (net outcomes). Guaranteed loss is defined as when the maximum net payout is negative across scenarios where any range may be the winning range.
   • If there is a guaranteed profit or loss, the net payouts for the Participant are adjusted by the amount of the profit or loss:
     • If there is guaranteed profit, the Participant’s net payout across all net outcomes is reduced by the amount of the profit, so that the minimum net payout is again $0.
       • The Participant’s available balance is credited by the amount of the profit and the Clearinghouse pool account is debited the same amount.
     • If there is a guaranteed loss, the Participant’s net payout across all net outcomes is increased by the absolute amount of the loss, so that the maximum net payout is again $0.
       • The Clearinghouse pool account is credited by the absolute amount of the loss and the Participant’s available balance is then debited by the same amount. Importantly, the debit of the Participant’s available balance in the case of a guaranteed loss occurs in the context of step 4 below, and therefore the Participant’s available balance does not resolve to a negative available balance. Guaranteed losses prior to settlement are effectively taken out of funds first locked to collateralize potential losses.
4. After adjusting the net payouts for profit and loss, the amount of marginal collateral required to support the new position is calculated as the the minimum net payout given the new position (or alternatively, the new max loss), minus the prior max loss.
   • If this difference in max losses is positive (collateral lock), then collateralization is ensured by debiting the Participant’s available balance and crediting the Clearinghouse pool account by the amount of the marginal collateral required.
   • If this difference in max losses is negative (collateral unlock), then over-collateralization is resolved by crediting the Participant’s available balance and debiting the Clearinghouse pool account by the amount of the over-collaterallization.
5. If the sequence above would cause the Participant to end with a negative available balance, then the limit order is not accepted and the Participant’s position is unchanged from the prior, fully-collateralized state.
6. At settlement, if a Participant has a long or short position in the winning range, or has not taken a position in the winning range but has a non-zero net payout in that winning range as a result of the net payout updating described in steps 2 and 3 above, then their available balance is credited by the sum of 1) their net payout for that winning range, and 2) their collateral locked in the Clearinghouse pool account (their current max loss). The Clearinghouse pool account is debited by the same amount.
   • For clarity, because a Participant’s net payout for the winning range may be negative, the settlement transaction may involve returning no funds to the Participant’s available balance (i.e., when the winning range was the, or one of the, max loss ranges for the Participant), or less than the amount of funds the Participant has locked in the Clearinghouse pool account at the time of settlement (i.e., when the winning range was not the range in which the Participant would have had the max loss but the Participant still had a negative net payout in the winning range).

The following Example 1 demonstrates how adding positions in different ranges to a portfolio at different prices affects collateralization requirements of Participants on both the long and short side, and how those Participants will benefit from collateral netting, while maintaining full collateralization. 

Step A: Initial Positions Established in Range 1 

Participants A and B start by executing a trade for 1 contract resulting in a short and long position, respectively, in Range 1 at a trade price of $5.  In this example, both Participants must post $5 of collateral to establish the Range 1 position.  Neither Participant has any other positions in their portfolio:

As shown above, if Range 1 wins: 

• Participant A loses the $5 of collateral they posted 
• Participant B gains $5  

Conversely, if Range 2 or Range 3 wins: 

• Participant A wins $5
• Participant B loses the $5 of collateral they posted 

The collateral required by Participant A (B) to establish the short (long) position in Range 1 was $5 because the maximum loss each Participant could realize is $5. Therefore, there are no efficiencies from collateral netting in this scenario. 

The Clearinghouse, therefore, holds $10 in total collateral ($5 from Participant A, and $5 from Participant B) to support the 1 contract of open interest.

Step B: Positions Added in Range 2 at Different Price

The following Step B demonstrates how adding a new range to their positions can begin providing collateral netting benefits to Participant A.

In this Step B, Participants A and B execute another trade for 1 contract in Range 2 resulting in a short and long position, respectively, at a trade price of $3, as shown below.  In this example, without collateral netting, Participant A sells the new position for $3 and must post $7 to cover the risk that Range 2 is the winning range, whereas Participant B buys the new position for $3, which is equal to the amount of collateral required to be posted to cover the risk that Range 2 is not the winning range.  The potential payouts from these added positions, however, change the maximum possible losses each Participant may face, as described below, thereby changing their collateral requirements when netting is applied.

• If Range 1 Wins, the following payouts would accrue to Participants A and B:  
  • Participant A loses their $5 of collateral supporting the Range 1 position, but gains $3 for winning their Range 2 position, for a net payout of -$2.  
  • Participant B wins $5 if Range 1 wins, but loses the $3 of collateral they posted to support their Range 2 position, for a net payout of +$2.
• If Range 2 Wins, the following payouts would accrue to Participants A and B:
  • Participant A loses the $7 of collateral supporting the Range 2 position, but gains $5 for winning their Range 1 position, for a net payout of -$2.  
  • Participant B wins $7 if Range 2 wins, but loses the $5 of collateral they posted to support their Range 1 position, for a net payout of +$2.
• If Range 3 Wins, the following payouts would accrue to Participants A and B:  
  • Participant A wins $5 and $3 due to their winning positions in Ranges 1 and 2, for a net payout of +$8.
  • Participant B loses the $5 and $3 of collateral supporting their positions in Ranges 1 and 2, respectively, for a net payout of -$8.

Net payouts are adjusted in the table above for each Participant after adding the new positions in Range 2.

Without collateral netting, Participant A would otherwise have to post $5 to collateralize the short position in Range 1 and $7 to collateralize the short position in Range 2 for a total collateral requirement of $12.  However, adding the second position to Participant A’s portfolio reduces the maximum loss from $5 to $2.  Participant A, therefore, is only required to post a total of $2 to ensure full collateralization of the portfolio, since by adding the short position in Range 2, Participant A ensured that at least 1 short position would settle in their favor.  Adding the second range to Participant A’s portfolio, therefore, reduces the total risk to the portfolio, and enables the Clearinghouse to unlock $3 in collateral by debiting the Clearinghouse pool account and crediting Participant A’s available balance by $3.

By contrast, the risk to Participant B’s long portfolio is not reduced by adding another long position in a different range, and Participant B is therefore required to post more collateral to cover that increased risk.  Participant B must post $5 to collateralize the long position in Range 1 and $3 to collateralize the long position in Range 2, for a total collateral requirement of $8. The addition of the new position in Range 2 increases Participant B’s maximum loss to $8, and therefore no collateral efficiency is available for Participant B’s current portfolio of long positions. 

The Clearinghouse still holds $10 in total collateral to now support the 2 contracts of open interest, but because of the difference between the potential losses to Participants A and B, only $2 of that collateral now comes from Participant A, whereas $8 is from Participant B.

Step C: Positions Added in Range 3 at Different Price

Participants A and B then execute yet another trade for 1 contract resulting in a short and long position, respectively, in Range 3 at a trade price of $2.  In this example, without collateral netting, Participant A sells the new Range 3 position for $2 and must post $8, whereas Participant B buys the new position for $2, which is equal to the amount of collateral required to be posted.

• If Range 1 wins, the following payouts would accrue to Participants A and B:  
  • Participant A loses the $5 of collateral posted to support their Range 1 position, but wins $3 and $2 due to their winning positions in Ranges 2 and 3, respectively, for a net payout of $0. 
  • Participant B wins $5 for their Range 1 position, but loses the $3 and $2 of collateral supporting their positions in Ranges 2 and 3, respectively, for a net payout of $0.
• If Range 2 wins, the following payouts would accrue to Participants A and B:
  • Participant A loses the $7 of collateral posted to support their Range 2 position, but wins $5 and $2 due to their winning positions in Ranges 1 and 3, respectively, for a net payout of $0.
  • Participant B wins $7 for their Range 2 position, but loses the $5 and $2 of collateral supporting their positions in Ranges 1 and 3, respectively, for a net payout of $0.
• If Range 3 wins, the following payouts would accrue to Participants A and B:
  • Participant A loses the $8 of collateral posted to support their Range 3 position, but wins $5 and $3 due to their winning positions in Ranges 1 and 2, respectively, for a net payout of $0.
  • Participant B wins $8 for their Range 3 position, but loses the $5 and $3 of collateral supporting their positions in Ranges 1 and 2, respectively, for a net outcome of $0.

Net payouts are again adjusted in the table above for each Participant after adding the new positions in Range 3.

As described above, the risk to Participant A’s short portfolio is further reduced by adding a third range outcome, thereby further reducing the total amount of collateral Participant A is required to post.  In the absence of collateral netting, Participant A would otherwise have to post $5 to collateralize the short position in Range 1, $7 to collateralize the short position in Range 2, and $8 to collateralize the short position in Range 3, for a total collateral requirement of $20. However, adding a short position in Range 3 to Participant A’s portfolio reduced the maximum loss from $2 to $0, so $2 in collateral can be debited from the Clearinghouse pool account and credited to Participant A.  By adding that short position in Range 3, Participant A ensured that two short positions would settle in their favor and the portfolio at settlement would be worth $20 with certainty.  The difference between the maximum and minimum net payouts for Participant A is now $0.

The risk to Participant B’s long portfolio is also reduced by adding a long position in Range 3, since Participant B is now guaranteed to win one of their three trades.  In the absence of collateral netting, Participant B would have to post $5 to collateralize the long position in Range 1, $3 to collateralize the long position in Range 2, and $2 to collateralize the long position in Range 3, for a total collateral requirement of $10.  Before adding the new position in Range 3, Participant B had a maximum loss of $8.  By adding a long position in Range 3, however, Participant B now has a maximum loss of $0, and therefore $8 in collateral can be unlocked by debiting the Clearinghouse pool account and crediting Participant B’s available balance by the same amount. 

The Clearinghouse now holds $0 in total collateral despite the 3 contracts of open interest.

In this example, the sum of range prices equals the binary payout amount, and therefore buying or selling all ranges in equal sizes returns a net profit of $0 with certainty as there is no variability in net outcomes at settlement regardless of the winning range.  It would cost $20 ($10) in total to collateralize all three short (long) positions individually without collateral netting, but the portfolio of short (long) positions would return $20 ($10) with certainty at settlement.  This means that the portfolios described above, after adding the third positions, should not require any collateral under collateral netting, and instead collateral locked as a result of the first two trades can be returned to Participants prior to settlement.

In this instance, when settlement occurs there will be no settlement payment after determining the winning range as both Participants have maximum losses of $0 and net payouts of $0 in every net outcome scenario. 

This Example 2 demonstrates how adding multiple contracts in a single range to a previously risk-neutral portfolio requires Participants to re-collateralize based on the new risks associated with establishing the new position.   

As described in Step C of Example 1 above, each Participant begins this Example 2 with $0 of collateral posted to support the three open contracts in Ranges 1, 2, and 3, and has a net payout of $0 in all net outcomes.  In this Example 2, those same Participants further modify their portfolios from the end of Example 1 by executing three contracts in Range 3 with a trade price of $7, resulting in unequal position sizes across ranges.   Participant A (B) now has a total of 4 contracts short (long) in Range 3 as a result of 1 contract previously sold (bought) at $2 and 3 contracts sold (bought) at $7.  Positions in Ranges 1 and 2 are unchanged from the end of Example 1. 

The prices for Ranges 1, 2, and 3 in the table below reflect the prices for each of those ranges at the time the new trade is entered into for this Example 2.  Prior to entering this Example 2 trade, the portfolios of Participants A and B were fully collateralized, and no additional collateral is required for those pre-existing positions (notwithstanding the subsequent change in prices), since the winning range would result in a net-zero settlement outcome for each Participant given the collateralization at the end of Example 1.  By adding the new positions in Range 3, however, new collateral must be posted to account for the new risk arising from those added positions.  

The table below shows the changes from both Participants’ prior net payout values of $0 resulting from the new Range 3 position.

• If Range 1 wins, the following payouts would accrue to Participants A and B:
  • Participant A wins $21 due to their new position in Range 3.   
  • Participant B loses the $21 of collateral they posted to support their position in Range 3.  
• If Range 2 wins, the following payouts would accrue to Participants A and B: 
  • Participant A wins $21 due to their new position in Range 3.  
  • Participant B loses the $21 of collateral they posted to support their position in Range 3.  
• If Range 3 wins, the following payouts would accrue to Participants A and B,: 
  • Participant A loses the $9 of collateral posted to support their new position in Range 3.  
  • Participant B wins $9 for their position in Range 3.  

After the new trade for three contracts in Range 3, the maximum loss for each Participant once again is greater than $0.  Participant A would lose $9 if Range 3 wins, and Participant B would lose $21 if either Range 1 or Range 2 wins.  To fully collateralize those payout risks, therefore, the Clearinghouse now holds $30 total from the two Participants ($9 from Participant A, and $21 from Participant B) to collateralize 6 contracts of open interest.

In Example 3, the Participants started with no existing positions and then executed the following two trades:

• Participant B buys 1 contract of Range 1 from Participant A at price $1
• Participant B buys 1 contract of Range 2 from Participant A at price $2

At this point, Participant A could lose up to $7 and Participant B could lose up to $3, so the Clearinghouse would require each Participant to post those sums as collateral, for a total of $10 in the Clearinghouse pool account to support those 2 contracts of open interest.

Participants A and B then execute a third trade:

• Participant B buys 1 contract of Range 3 from Participant A at price $6

Under this portfolio, there is now a guaranteed profit (loss) of $1 for Participant B (Participant A), and therefore $1 of the $10 that the Clearinghouse previously held can be unlocked from the Clearinghouse pool account and credited to Participant B.  Participant A similarly has $1 debited from their available balance and credited to the Clearinghouse pool account.

After the guaranteed profit and loss is resolved by decreasing (increasing) Participant B’s (A’s) net payouts in every net outcome by $1 so that the net payouts are again at $0, there is no longer any variability in portfolio value.

The net payout value of $0 in every net outcome also means that the $10 of collateral previously locked in the Clearinghouse collateral pool prior to the trade in Range 3 can be returned to the Participants.  Prior to executing the trade in Range 3, Participant A’s maximum loss was $7; this $7 can now be returned to Participant A because the maximum loss has decreased from $7 to $0.  Similarly, prior to executing the trade in Range 3, Participant B’s maximum loss was $3; this $3 can now be returned to Participant B because their maximum loss has decreased from $3 to $0.

The guaranteed profit for Participant B in this example arises from the fact that they purchased all of the mutually-exclusive outcomes, which would require $9 in total to collateralize without netting, but which together will return $10 at settlement with certainty.  Similarly, the guaranteed loss for Participant A arises from the fact that they sold all of the mutually-exclusive outcomes which would require $21 in total to collateralize without netting, but for which only two would settle in their favor, and their portfolio would be worth only $20 with certainty at settlement.

At the end of the net outcomes procedure, the Clearinghouse holds $0 to collateralize 3 contracts of open interest and no settlement payment is due to either Participant due to their $0 max loss and $0 net payouts in every net outcome.