• IBANK Part 6.3 IBANK Part 6.3 Options Risk

    • IBANK Division 6.3.A IBANK Division 6.3.A General

      • IBANK 6.3.1 Relation to Market Risk

        In measuring its market risk, an Islamic banking business firm must include the risk of holding or taking positions in options contracts (options risk).

        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.2 Measuring Options Risk

        (1) An Islamic banking business firm that does not write options must use the simplified approach.
        (2) An Islamic banking business firm that writes options must use the delta-plus method.

        Note If all the written option positions are hedged by perfectly matched long positions in exactly the same options, no capital charge for options risk is required.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

    • IBANK Division 6.3.B IBANK Division 6.3.B Simplified Approach

      • IBANK 6.3.3 IBANK 6.3.3 Using simplified Approach

        An Islamic banking business firm that does not write options must calculate capital charges in accordance with:

        (a) rule 6.3.4 for a position that is a 'long cash and long put' or 'short cash and long call' position; or
        (b) rule 6.3.5 for a position that is a 'long put' or 'long call' position.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

        • IBANK 6.3.3 Guidance

          In the simplified approach, the position in the option and the associated underlying asset (cash or forward) is not subject to the mark-to-market method. Instead, each position is carved-out and is subject to a separately calculated capital charge for specific risk and general risk.

          Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.4 Capital Charges — 'Long Cash and Long Put' or 'Short Cash and Long Call'

        (1) For a position that is 'long cash and long put' or 'short cash and long call', the capital charge is calculated by multiplying the market value of the underlying security by the sum of the specific and general risk capital charges for the underlying, and then subtracting the amount by which the option is in-the-money (bounded at zero).

        Guidance
        1 In cases (such as foreign exchange transactions) where it is unclear which side is the underlying security, the underlying should be taken to be the asset that would be received if the option were exercised. In addition, the nominal value should be used for items if the market value of the underlying instrument could be zero (such as in caps, floors and swaptions).
        2 Some options have no specific risk (such as those having a profit rate, currency or commodity as the underlying security); other options on profit-rate-related instruments and options on equities and stock indices, however, would have specific risk.
        (2) In the simplified approach, the capital charge is:
        (a) 8% for options on currency; and
        (b) 15% for options on commodities.
        (3) For options with a residual maturity of less than 6 months, an Islamic banking business firm must use the forward price (instead of the spot price) if it is able to do so.
        (4) For options with a residual maturity of more than 6 months, the firm must compare the strike price with the forward price (instead of the current price). If the firm is unable to do this, it must take the in-the-money amount to be zero.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.5 Capital Charges — 'Long Put' or 'Long Call'

        (1) For a position that is 'long put' or 'long call', the capital charge is the lesser of:
        (a) the market value of the underlying security multiplied by the sum of the specific and general risk capital charges for the underlying; and
        (b) the market value of the option.
        (2) For subrule (1)(b), the book value of the option may be used instead of the market value if the position is not included in the trading book (for example, options on particular foreign exchange or commodities positions).
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

    • IBANK Division 6.3.C IBANK Division 6.3.C Delta-Plus Method

      • IBANK 6.3.6 Using Delta-Plus Method

        (1) An Islamic banking business firm that writes options must calculate specific risk capital charges separately by multiplying the delta-equivalent value of each option by the risk-weight applicable under Part 6.5 (equity position risk) and Part 6.6 (profit rate risk in the trading book).
        (2) In calculating general risk capital charge, the firm must enter delta-weighted positions with a debt security or profit rate as the underlying into the profit rate time bands in table 6.6.8A by using a two-legged approach. Under this approach, there is 1 entry at the time the underlying contract takes effect and a second entry at the time the underlying contract matures.
        (3) For an option with a debt security as the underlying, the firm must apply a specific risk capital charge to the delta-weighted position based on the issuer's rating and in accordance with Part 6.6.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.7 Relation to Mark-to-Market Method

        (1) An Islamic banking business firm that writes options must include delta-weighted option positions in measuring its market risk.
        (2) The firm must report such an option as a position equal to the sum of the market values of the underlying multiplied by the sum of the absolute values of the deltas. Because delta does not cover all risks associated with option positions, the firm must calculate gamma and vega in calculating the regulatory capital charge.

        Note Gamma is the rate of change of delta with respect to a change in the price of the underlying. Vega is the sensitivity of the value of an option to a change in the volatility of the underlying.
        (3) The firm must calculate delta, gamma and vega using the pricing model used by a recognised exchange, or a proprietary options pricing model approved, in writing, by the Regulatory Authority.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.8 Capital Charges — Options

        (1) The capital charge for an option with equities as the underlying must be based on the delta-weighted positions included in the measurement of specific and general risks in accordance with Part 6.5. (equity position risk).
        (2) An Islamic banking business firm that writes options must calculate the capital charge for options on foreign exchange and gold and silver positions in accordance with Part 6.2 (foreign exchange risk). For delta risk, the net delta-based equivalent of the foreign currency, gold and silver options must be included in the measurement of the exposure for the respective currency, gold or silver position.
        (3) The capital charge for an option on commodities must be based on the charge calculated using the simplified approach in rule 6.4.6.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.9 Gamma Capital Charges

        (1) An Islamic banking business firm that writes options must calculate the capital charge for gamma risk (gamma capital charge) for each option position separately.
        (2) To calculate gamma capital charge, calculate the gamma impact of each option in accordance with the following formula:

        Gamma impact = 1/2 × gamma × VU2

        where:

        VU is:x
        (a) for a profit rate option:
        (i) if the option has a bond as the underlying — the market value of the underlying multiplied by the risk factor applicable under column 3 of table 6.6.8A; or
        (ii) if the option has a profit rate as the underlying — the market value of the underlying multiplied by the assumed changes in yield in column 4 of table 6.6.8A;
        (b) for options on equities and stock indices — the market value of the underlying multiplied by 8%;
        (c) for options on foreign exchange, gold and silver — the market value of the underlying multiplied by 8%; or
        (d) for an option on commodities — the market value of the underlying multiplied by 15%.
        (3) In calculating the gamma impact for an option mentioned in the definition of VU, the firm must treat as the same underlying:
        (a) for profit rates — each time band in column 2 of table 6.6.8A (with each position allocated to separate maturity ladders);
        (b) for equities and stock indices — each recognised exchange;
        (c) for foreign currencies, gold and silver — each currency pair, gold and silver; and
        (d) for commodities — each individual commodity of a kind described in rule 6.4.2(3)(a) or (b).
        (4) Each option on the same underlying described in subrules (2) and (3) will have a gamma impact that is positive or negative. The firm must add the individual gamma impacts, resulting in a net gamma impact for each underlying that is either positive or negative.
        (5) To calculate the firm's total gamma capital charge, exclude gamma impacts that are positive. The total gamma capital charge is the sum of the absolute values of the net negative gamma impacts.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).

      • IBANK 6.3.10 Vega Capital Charges

        (1) An Islamic banking business firm that writes options must calculate the capital charge for vega risk (vega capital charge) for each option position separately.
        (2) To calculate vega capital charge, the firm must multiply the vega for each option mentioned in the definition of VU in rule 6.3.9(2) by a 25% proportional shift in the option's current volatility. The results must then be summed across each underlying.
        (3) The total vega capital charge is the sum of the absolute values of the vega capital charges across each underlying.
        Derived from QFCRA RM/2015-2 (as from 1st January 2016).