Thursday, May 5, 2011

CME gets aggressive with Silver margins!

Firstly if you aren't a regular reader of the blog, you can see my previous posts on CME margin increases here (from 1 week ago) and here (from 6 weeks ago). In the article from 6 weeks ago I explain the need for margin increases (as Silver increases so does the contracts value, hence the CME needs to raise margins so that market participants do not over leverage), in the more recent article I show that the margin increases are still only "keeping up" with the price of Silver.

In a very short period of time we have seen the CME load up the margin requirements for Silver, 5 times in 8 days according to Zero Hedge.

As I have explained in the previous posts the CME seems to be keeping the leverage steady, it has fluctuated though with the average being around 15 to 1 (for spec traders).

Silver has taken a fairly large hit since the news of the latest round of margin increases, but at the time of the announcement Silver was $42. So each 5000 ounce Silver contract was worth $210,000. The CME announced the initial margin for spec traders would rise to $18,900 as of May 5th and $21,600 as of May 9th. At $42 Silver this would have allowed 11 to 1 leverage from May 5th and 10 to 1 leverage from May 9th. Both these numbers are well below the average level of leverage that the CME has allowed in the previous 6 months.

I can only speculate on why the CME has chosen to reduce the level of leverage allowed in the Silver market. It's possible they just want to get ahead of the curve and are expecting a further rise in the price of Silver. Perhaps their data is pointing to a large number of traders being stopped out of the market and wanted to reduce volatility. Perhaps Blythe Masters (head of JPM Commodities unit) called up the head of the CME and asked them to 'hit' Silver because they wanted to cover some shorts (joking on that last one by the way!).

Here is what the CME has to say about the recent increases:

With recent geopolitical events and natural disasters driving volatility in financial markets, margins – good-faith deposits to guarantee performance on open positions – have spent more time than usual under the limelight.

So we thought it might help to provide a very brief primer on margins as part of this conversation.

At CME Group, we’re intently focused on risk management. In over a century, we have not experienced a default. In more than a century, there has never been a failure by a clearing member to meet a performance bond call or its delivery obligations; nor has there been a failure of a clearing member firm resulting in a loss of customer funds. As part of our overall risk management program, margins are adjusted frequently across all of our products based on market volatility. When daily price moves become more volatile, we typically raise margins to account for the increased risk. Likewise, when daily price moves become less volatile, margins typically go down because the risk of the position also decreases.

Margins are set as part of the neutral risk management services we provide. They aren’t a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another. Rather, margin is one of many risk management tools that help us assess overall portfolio risk to protect market participants and the market as a whole.

There are two main margin philosophies that clearing houses can have. First, a clearing house could set margins sufficiently high to cover all possible volatility environments. Changes are less frequent, but margins are higher. Second, and the CME Clearing approach, is to ensure that margins are set to cover 99 percent of the potential price moves. Margins then are lower in less volatile periods and higher in more volatile periods. Changes are often made when the volatility environment experiences a sustained change.

Who determines margin, and what goes into setting margin levels?

At CME Group, CME Clearing is responsible for setting margins. In doing so, we consider several factors to compute the gains and losses a portfolio would incur under different market conditions. Then we calculate the worst possible loss a portfolio might reasonably incur in a set time (usually one trading day for futures markets).

CME Clearing determines “initial margin,” which is the margin that market participants must pay when they initiate their position with their clearing firm, as well as “maintenance margin,” the level at which market participants must maintain their margin over time. We mark positions to market twice a day to prevent losses from accumulating over time. We typically change margins after a market closes because we have a full view of the market liquidity of that trading day. And, we also provide at least 24 hours notice of margin changes to give market participants time to assess the impact on their position and make arrangements for funding.

In the case of silver, we have made several changes in margin in recent weeks to adjust to volatility in the marketplace. By the close of business Thursday, May 5, the margin when a position is initiated will be $18,900; throughout the life of that trade, we would expect $14,000 in maintenance margin would be kept at the clearing house. By the close of business Monday, May 9, the margin when a position is initiated will be $21,600, and we would expect open positions to keep $16,000 in maintenance margin at the clearing house. This is similar to when you sign up for a checking account – a bank will typically require a minimum initial deposit and can then stipulate that you maintain a certain balance going forward.

It also is important to mention that the way margins are calculated has to be tailored to the market served. For example, portfolio margins for our listed derivatives are based on the CME Standard Portfolio Analysis of Risk (SPAN). CME SPAN is the industry standard for portfolio margins used by more than 50 other global exchanges, clearing organizations, service bureaus and regulatory agencies. Margins for credit default swaps and interest rate swaps are quite different because those markets behave differently and have different kinds of variables that produce risk.

As an industry-leading clearing provider, our risk management methodologies have to work to protect the markets we serve. Our interest is in providing security for the entire market – no matter which way it moves. CME
It's worth noting that as of 8.30pm tonight in Adelaide the price of Silver is currently US$37.50, giving a 5000 ounce contract a $187,500 value. If we were at the same Silver price or lower come Monday when the CME increases the initial margin to $21,600 then we'd be looking at initial margins allowing around 8.5 to 1 leverage (almost half the average). If Silver continues to consolidate around this level or falls lower then it's likely that the CME will start to LOWER margins as they did on multiple occasions in 2009 and 2010.

I still don't think there is a conspiracy here.

Although the correction in price has been steep, I feel it has been a healthy correction. It has cleared out a lot of speculative traders. Many short term technical indicators have been reset back to oversold (from overbought) levels. As per my post early this morning I still believe the bottom of this correction will lie between $36 to $38. I think a move significantly below $36 is unlikely before we see $50 again.

Of course I could be wrong. Silver could fall further.

Hopefully this correction gets investors minds in the right place. If you thought a correction as significant as this wasn't possible, now you know it is. If you feel uncomfortable with such a correction then maybe you should question your investment in precious metals at all. Perhaps Gold should form a larger part of your portfolio if the volatility in Silver doesn't let you sleep at night.

I have only been investing in precious metals for 3 years. The last time I saw a correction as volatile as this was in 2008. I bought my first kilo of Silver within days of the March 2008 top. I welcomed the correction as I was buying hand over fist into the lows later that year. For me the correction was a miracle. A chance to buy a quality asset for ridiculously low prices. Although this correction may have further to go I also believe that there will be many that are buying the correction today that will look back in a year or two and realise that this was an opportunity. Will you be one of those people?


Disclosure: Positions held in Gold & Silver. Not investment advice. Do your own research.


  1. Bullion Barron....thanks for the excellent summary of the silver margin story. The entire episode makes one wonder why we allow margin based pricing to cause such wild fluctuations in asset prices. Is it moral and ethical to do so? Certainly, one has to question the ethics of an industry that allows margin requirements to be changed midstream. Why should a commodity price be dependent on margin requirements....allowing such places far too much reliance in the integrity of the entity setting the margin rates....and history shows that when it comes to money, relying on the integrity of an entity with this much power is ill advised.

    Consider the real estate market. Many homes were sold at 10 to 1, 20 to 1, or even 33 to 1 leverage....remember the 3% down mortgages? Why was this level of frenzied speculation allowed and who benefitted by it. Imagine if banks changed their margin requirements after making mortgage loans....requiring people to sell their homes. Imagine the outrage in that scenerio.

    There is a much bigger story here that people need to look into. The story of silver this week does provide evidence of collusion and corruption. Broaden your research. For example, What I'd love a regulator to look at is who was short the silver mining equities, as well as SLW....and who ramped up their shorts during the last 3 weeks of April. Sadly....there appears to be no regulation in this country for that type of conduct....

    SLW's share price is very correlated to SLV.....yet SLW fell $6.98 per share from its high on April 8th to the close on April 29th....while SLV rallied $6.98 per share from its high on April 8th to the close on April exact match in the opposite direction for two investments that should trade in the same direction. What are the odds of this?

    The two resumed their trading in the same direction between the close on April 29th, and the open on May 2nd.....SLW gapping down $2.42 at the open and SLV gapping down $2.78 at the open on May 2nd. Based on the relationship of the two silver investments between the highs on April 8th and the close on April 29th, why didn't SLW gap up $2.78 per share on May 2nd when SLV gapped down $2.78?!? The concept is laughible of course....just as laughable as the divergence between silver investments and the price of silver between April 8th and April 29th.

    Bullion Baron....who do you think was provided advance notice of the margin increases? Why was SLW shorted and sold as Silver rose strongly toward $50.

    I have little faith in the integrity of our markets, entities like the Comex and CME and our regulators. Silvers volatility as of late says it all....the volatility is a direct result of the unethical conduct of these entities...plain and simple. Silvers fundamentals have not changed over the last six weeks....why the wild price fluctuations and who benefitted from it. It is shameful and speaks poorly for our country.

  2. Anon, thanks for the detailed response. Some of the CME margin activities (e.g. announcing coming changes during course of trade) do make me wonder whether there is a better way. For example rather than a fixed margin requirement, why not have these requirements set as a % of the contract size? That way it rises and falls inline with the value of the contract. It would avoid knee jerk reactions like we’ve seen from the CME over the last week.

    Regarding the shares, they certainly hadn’t participated in the latest Silver runup, there was some speculation that might be due to hedge funds shorting the stocks while going long the metal directly. That explanation would certainly fit given the stocks are now holding up a lot better than the metal itself.

  3. Thanks Bullion, my hope is that this episode will put a spotlight on the nefarious activities of entities like the CME as well as expose the failures of the CFTC to regulate the industry.

    Regarding the shares....I understand that hedging for regular mining entities.....but SLW is a different animal. Hedging a 25% increasse in the price of Silver by shorting SLW is an extremely risky strategy, one I suspect was only done after assurances were made that margins would be increased at a certain future date.....

  4. What is the corresponding margin for physical metal on deposit in their vaults? Does it correspond with reality?

  5. In finance, volatility is a measure for variation of price of a financial instrument over time.

    Silver hit a 40 day closing low of $26.81 on January 25, 2011. From that closing low, silver commenced an orderly move up to close at $46.57 on April 21, 2011, the last close before Easter.
    The Daily Range, defined as the difference between the high price of the day and the low price of the day, is a very reasonable method of measuring volatility. The Daily Range for silver’s continuous contract, averaged $1.046 during the 62 day period from January 25, 2011 to April 21, 2011.

    During that 62 day period the largest Daily Range for Silver was $2.34 on March 15, 2011, a day in which silver ranged between a high of $35.92 and a low of $33.58.

    On April 25, 2011, the CME group announced the first of 5 margin increases that would become effective between April 26, 2011 and May 9, 2011. CME Clearing President Kim Taylor has represented that they did so to adjust to volatility in the marketplace. My opinion is that the evidence suggests that the CME was reacting to Silver’s price level rather than to volatility in the marketplace. Supporting my opinion is the fact that the CME group’s margin adjustments have greatly accelerated volatility in the marketplace.

    Immediately after CME’s April 25, 2011 announcement, silver’s price volatility intensified dramatically. The Daily Range for silver’s continuous contract, averaged $3.67 during the 9 day period from April 25, 2011 to May 5, 2011, over 3.5 times the average daily range during the 62 day period from January 25, 2011 to April 21, 2011.

    During that 9 day period the largest Daily Range for Silver was an astonishing $5.66 on May 2, 2011, a day in which silver ranged between a high of $48.11 and a low of $42.45. The Daily Range for Silver was $5.29 on May 5, 2011 and $4.93 on May 3, 2011. As a long time silver investor, I remember days as recently as 2002 and 2003 when silver’s total price was less than $4.93!

    The following questions must be answered. Why did the CME group raise margins 5 times in a very short period of time when Silver’s price appreciation had been very orderly? Why is the CME group planning to raise margin requirements again on May 9, 2011 when they can clearly see that their first four margin increases have caused a massive sell off in silver as well as the associated volatility?