Modeling Funding Costs for Hedged Options Positions

Summary

The document asks how to assign funding costs to options in a profit-and-loss model, especially when options are hedged with physical equities or bonds. It contrasts funding charges on securities, which may be financed or lent through repo, with futures’ daily variation margin, which creates realized cash flows. The author argues that funding an options position at the rate applicable to its corresponding physical hedge can make a synthetic forward’s financing treatment consistent.

For a short synthetic forward backed by long spot, the proposed approach recognizes a funding credit when the derivative’s market value moves against the position, since that value remains in the account unless the trade is closed. The discussion also flags clearinghouse collateral requirements as a separate consideration, mentioning the OCC’s STANS model without working through its impact. This is a practitioner’s proposed accounting framework, not a settled convention or a comparison of alternative models; it offers no numerical example or empirical validation.

Key ideas

• Funding assumptions for options affect modeled P&L, particularly when a position includes a physical hedge.
• The author proposes using a funding rate aligned with the corresponding physical-equity hedge to keep synthetic-forward economics consistent.
• Under that approach, a short synthetic forward may receive a funding credit when its derivative value moves against the position.
• Clearinghouse collateral requirements may add a separate funding consideration, but the document does not analyze them.

Tags

# Funding Cost of Options


# Funding Cost of Options












What is the best way to assign an internal funding cost of options in your PNL model? If you hold physical equities or bonds, you will be charged OBFR/FF/SOFR + some spread, which makes sense given that these can be repoed out for cash. For certain derivatives like futures with daily cash settled VM, any change in market value is real PNL in your account.

In a hedged options position (say listed european to keep it simple) there is a component of unrealized pnl. If you’re short a FWD synthetically vs long spot, your daily financing costs on your long equities will increase over the life of the trade, especially if you have an oversimplified funding cost attributed to the options, like cost basis.

For me theoretical funding equal to the corresponding physical equities hedge makes the most sense. This ties out in a synthetic fwd sense. In the example of being short a synthetic fwd, you get relief on the derivative funding cost when it moves against you (you are getting a funding credit = to OBFR on the market value of the options). This is also the amount of $ you keep today by not closing out the position.

I understand there is also a component of the margin in the form of collateral with the OCC stans model. Though this is another rabbit hole, I am curious on thoughts from whoever dealt with this before.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.