This option method suggests aluminium has an $80/Mt risk over 2 days (compared to an IM of $170/ Mt), and copper has a risk of $216/Mt (c.f. LME Cu IM of $494/Mt).


However, some back testing of actual LME 3m aluminium data between Sept 2008 and Sept 2018 suggests that the current LME IM of $170/Mt is a better, more prudent measure of historical 2 day risk at 99% confidence.


The chart uses daily LME 3m Aluminium data (Open-High-Low-Close) for the 10 year period 18 Sept 2008 to 17 Sept 2018 (covering 2525 trading days) and shows two day data as follows:


• Cumulative histogram for a Rising Market, being the D+2 High minus D Low


» 99% of the 2 day rise is =< $160/Mt, i.e. more positive on 25 days


• Cumulative histogram for a Falling Market, being the D+2 Low minus D High


» 99% of the 2 day fall is =<-$160/Mt, i.e. more negative on 25 days


• Histogram for all data, being D+2 Close minus D Close


» 98% of the data is approximately within +$100 to -$100 (i.e. 1% higher, 1% lower), reflecting lower Close/Close risk compared to the daily High-Low range.


Based on 2525 days of data, a 99% confidence level suggests that the IM is effective on 2500 days and is exceeded on 25 days. Applying this criteria to the historical data suggests an approx. range of +/- $160/Mt (area inside the blue box), which is in line with the current LME Aluminium Initial Margin of $170/Mt.


Chart 4


0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1


0 Source: ADMISI LME Desk, Data: Reuters / LME


Falling Mkt Rising Mkt Close-Close


100 200 300 400 500 600 700


0


Applying this analysis to LME 3m Copper over the same period suggests a 99% range circa -$650 to +$650/Mt for the volatile 2 day High-Low data (blue box), above the LME’s $494/MT Initial Margin, or +/- $350 range basis two day Close–Close data (green dashed box).


Analysis of the historical data undermines the case for lower Initial Margins for outright LME positions suggested by an implied volatility/options based approach, certainly over short 2 day periods, (although an options based approach has merit for use in longer dated Potential Future Analysis (PFE) as an alternative to binomial expansion models used currently).


However, there appears to be a good case for reviewing Initial Margins on spread trades, to better reflect:


• Differences in risk between “borrowing” or “lending”


• The level at which the spread is traded compared to the market and limit of full finance.


In summary, although LME margins need to be conservative to protect against occasionally volatile markets, a review of margins on spread trades could help the LME attract more business.


Sir Bobby Robson (the late, great football manager) once said that “the margin is very marginal”, but margins could be crucial in the LME’s fight to increase trading volumes.


Rohan Ziegelaar E: metals.desk@admisi.com T: +44(0) 20 7716 8081


19 | ADMISI - The Ghost In The Machine | September/October 2018


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