Related provisions for BIPRU 7.6.16

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To access the FCA Handbook Archive choose a date between 1 January 2001 and 31 December 2004 (From field only).

BIPRU 7.6.1RRP
A firm must calculate its optionPRR by:(1) identifying which optionpositions must be included within the scope of the optionPRR calculation under BIPRU 7.6.3R - BIPRU 7.6.5R;(2) calculating the derived position in each option in accordance with BIPRU 7.6.9R - BIPRU 7.6.15R;(3) calculating the PRR for each derived position in accordance with BIPRU 7.6.16R - BIPRU 7.6.31R;(4) summing all of the PRRs calculated in accordance with (3).
BIPRU 7.6.2GRP
Firms are reminded that the table in BIPRU 7.2.4R (Instruments which result in notional positions for the purposes of the interest rate PRR) and the table in BIPRU 7.3.3R (Instruments which result in notional positions for the purposes of the equity PRR) also require an interest rate PRR to be calculated for options on equities, baskets of equities or equities indices. The interaction between BIPRU 7.6 and the rest of Chapter 7 is illustrated in BIPRU 7.6.33G.
BIPRU 7.6.7RRP
(1) The appropriate position risk adjustment for a position is that listed in the table in BIPRU 7.6.8R against the relevant underlying position.(2) If the firm uses the commodity extended maturity ladder approach or the commodity maturity ladder approach for a particular commodity under BIPRU 7.4 (Commodity PRR) the appropriate position risk adjustment for an option on that commodity is the outright rate applicable to the underlying position (see BIPRU 7.4.26R (Calculating the
BIPRU 7.6.14RRP
A firm may treat (for the purpose of calculating an option PRR under BIPRU 7.6) an option strategy listed in the table in BIPRU 7.6.15R as the single position in a notional option specified against that strategy in the table in BIPRU 7.6.15R, if:(1) each element of the strategy is transacted with the same counterparty;(2) the strategy is documented as a single structure;(3) the underlying for each part of the composite position (including any actual holding of the underlying)
BIPRU 7.6.18RRP

Table: Option PRR: methods for different types of option

This table belongs to BIPRU 7.6.16R

Option

Description

Method

American option

An option that may be exercised at any time over an extended period up to its expiry date.

Option standard method or option hedging method if appropriate

European option

An option that can only be exercised at expiry.

Bermudan option

A cross between an American option and European option. The Bermudan option can only be exercised at specific dates during its life.

Asian option

The buyer has the right to exercise at the average rate or price of the underlying over the period (or part of the period) of the option. One variant is where the payout is based on the average of the underlying against a fixed strike price; another variant is where the payout gives at expiry the price of the underlying against the average price over the option period.

Option standard method or option hedging method if appropriate

Barrier option

An option which is either cancelled or activated if the price of the underlying reaches a pre-set level regardless of the price at which the underlying may be trading at the expiry of the option. The knock-out type is cancelled if the underlying price or rate trades through the trigger; while the knock-in becomes activated if the price moves through the trigger.

Corridor option

Provides the holder with a pay-out for each day that the underlying stays within a defined range chosen by the investor.

Ladder option

Provides the holder with guaranteed pay-outs if the underlying trades through a pre-agreed price(s) or rate(s) at a certain point(s) in time, regardless of future performance.

Lock-in option

An option where the pay-out to the holder is locked in at the maximum (or minimum) value of the underlying that occurred during the life of the option.

Look-back option

A European style option where the strike price is fixed in retrospect, that is at the most favourable price (i.e. the lowest (highest) price of the underlying in the case of a call (put)) during the life of the option.

Forward starting option

An option that starts at a future date.

Compound option

An option where the underlying is itself an option (i.e. an option on an option).

Option standard method or option hedging method if appropriate

Interest rate cap

An interest rate option or series of options under which a counterparty contracts to pay any interest costs arising as a result of an increase in rates above an agreed rate: the effect being to provide protection to the holder against a rise above that agreed interest rate.

Option standard method, but no reduction for the amount the option is out of the money is permitted

Interest rate floor

An interest rate option or series of options under which a counterparty contracts to pay any lost income arising as a result of a fall in rates below an agreed rate: the effect being to provide protection to the holder against a fall below that agreed interest rate.

Performance option

An option based on a reference basket comprising any number of assets, where the pay-out to the holder could be one of the following: the maximum of the worst performing asset, or 0; the maximum of the best performing asset, or 0; the maximum of the spreads between several pairs of the assets, or 0.

Option standard method or option hedging method - using the highest position risk adjustment of the individual assets in the basket

Quanto

Quanto stands for "Quantity Adjusted Option". A quanto is an instrument where two currencies are involved. The payoff is dependent on a variable that is measured in one of the currencies and the payoff is made in the other currency.

Subject to BIPRU 7.6.31R, the option standard method

Cliquet option

A cliquet option consists of a series of forward starting options where the strike price for the next exercise date is set equal to a positive constant times the underlying price as of the previous exercise date. It initially acts like a vanilla option with a fixed price but as time moves on, the strike is reset and the intrinsic value automatically locked in at pre-set dates. If the underlying price is below the previous level at the reset date no intrinsic value is locked in but the strike price will be reset to the current price attained by the underlying. If the underlying price exceeds the current level at the next reset the intrinsic value will again be locked in.

Option standard method for a purchased cliquet, or the method specified in BIPRU 7.6.30R for a written cliquet

Digital option

A type of option where the pay-out to the holder is fixed. The most common types are all-or-nothing and one-touch options. All-or-nothing will pay out the fixed amount if the underlying is above (call) or below (put) a set value at expiry. The one-touch will pay the fixed amount if the underlying reaches a fixed point any time before expiry.

The method specified in BIPRU 7.6.29 R

Any other option or warrant

The method specified for the type of instrument whose description it most closely resembles.

BIPRU 7.6.20RRP
Under the option standard method, the PRR for a purchased option or warrant is the lesser of:(1) the market value of the derived position (see BIPRU 7.6.9R) multiplied by the appropriate position risk adjustment (see BIPRU 7.6.8R); and(2) the market value of the option or warrant.
BIPRU 7.6.22RRP
Under the option standard method, the PRR for underwriting or sub-underwriting an issue of warrants is the net underwriting position (or reduced net underwriting position) multiplied by the current market price of the underlying securities multiplied by the appropriate position risk adjustment, but the result can be limited to the value of the net underwriting position (or reduced net underwriting position) calculated using the issue price of the warrant.
BIPRU 7.6.24RRP
Under the option hedging method a firm must calculate the option PRR for individual positions as follows:(1) for an option or warrant on an equity, basket of equities or equity index and its equity hedge(s), the firm must, to the extent specified or permitted in the table in BIPRU 7.6.26R, use the calculation in the table in BIPRU 7.6.27R;(2) for an option or warrant on a debt security, basket of debt securities or debt security index and its debt security hedge(s), the firm must,
BIPRU 7.6.26RRP

Table: Appropriate treatment for equities, debt securities or currencies hedging options

This table belongs to BIPRU 7.6.24R

Hedge

PRR calculation for the hedge

Limits (if hedging method is used)

Naked position

An equity (hedging an option or warrant)

The equity must be treated in either BIPRU 7.3 (equity PRR) or the option hedging method (see the table in BIPRU 7.6.27R)

The option hedging method must only be used up to the amount of the hedge that matches the notional amount underlying the option or warrant

To the extent that the amount of the hedge (or option or warrant) exceeds the notional amount underlying the option or warrant (or hedge), a firm must apply an equity PRR, interest rate PRR or foreign currencyPRR (or the option standard method)

A debt security (hedging an option or warrant)

The debt security must be treated in BIPRU 7.2 (interest rate PRR) or the option hedging method (see the table in BIPRU 7.6.27R)

As for the first row

As for the first row

Gold (hedging a gold option)

The gold must be treated in either BIPRU 7.5 (Foreign currency PRR) or the option hedging method (see the table in BIPRU 7.6.27R)

As for the first row

As for the first row

A currency or currencies (hedging a currency option)

The currency must be treated in either BIPRU 7.5 (Foreign currency PRR) or the option hedging method (see the table in BIPRU 7.6.28R)

As for the first row

As for the first row

BIPRU 7.6.27RRP

Table: The hedging method of calculating the PRR (equities, debt securities and gold)

This table belongs to BIPRU 7.6.24R(1) - (3)

PRR

Option or warrantposition

In the money by more than the position risk adjustment

In the money by less than the position risk adjustment

Out of the money or at the money

Long in security or gold

Long put

Zero

Wp

X

Short call

Y

Y

Z

Short in security or gold

Long call

Zero

Wc

X

Short put

Y

Y

Z

Where:

Wp means

{(position risk adjustment-100%) x The underlying position valued at strike price}

+

The market value of the underlying position

Wc means

{(100% +position risk adjustment x The underlying position valued at strike price}

-

The market value of the underlying position

X means

The market value of the underlying position multiplied by the appropriate position risk adjustment

Y means

The market value of the underlying position multiplied by the appropriate position risk adjustment. This result may be reduced by the market value of the option or warrant, subject to a maximum reduction to zero.

Z means

The option hedging method is not permitted; the option standard method must be used.

BIPRU 7.6.28RRP

Table: The hedging method of calculating the PRR (currencies)

This table belongs to BIPRU 7.6.24R(4)

PRR

Optionposition

In the money by more than 8%

In the money by less than 8%

Out of the money or at the money

Long calls & long puts

Zero

WL

X

Short calls & short puts

Zero

Y

X

Where:

WL means

(1.08% x U)

-

The market value of the underlying position

U means

The amount of the underlying currency that the firm will receive if the option is exercised, converted at the strike price into the currency that the firm will sell if the option is exercised

X means

The market value of the underlying position multiplied by 8%.

Y means

The market value of the underlying position multiplied by 8%. This result may be reduced by the market value of the option, subject to a maximum reduction to zero.

BIPRU 7.6.36GRP
(1) This paragraph gives an example of how the appropriate position risk adjustment should be calculated for the purpose of deciding whether or not an option on a CIU is sufficiently in the money for the firm to have a choice whether or not to apply an option PRR. This example assumes that there is no leveraging (see BIPRU 7.7.11R (CIU modified look through method)).(2) Say that the CIU contains underlying equityposition and the firm is using one of the CIU look through methods.
BIPRU 7.2.3RRP
A firm's interest rate PRR calculation must:(1) include all trading bookpositions in debt securities, preference shares and convertibles, except:(a) positions in convertibles which have been included in the firm'sequity PRR calculation;(b) positions fully deducted as a material holding under the calculations under the capital resources table, in which case the firm may exclude them; or(c) positions hedging an option which is being treated under BIPRU 7.6.26R (Table: Appropriate
BIPRU 7.2.32RRP
(1) Where included in the PRR calculation in BIPRU 7.2 (see the table in BIPRU 7.2.4R), options and warrants must be treated in accordance with this rule.(2) An option or warrant on a debt security, a basket of debt securities or a debt security index must be treated as a position in that debt security, basket or index.(3) An option on an interest rate must be treated as a position in a zero coupon zero-specific-risk security with a maturity equal to the sum of the time to expiry
BIPRU 7.2.35RRP

Table: Interest rate risk on other futures, forwards, options and swaps

This table belongs to BIPRU 7.2.34R.

Instrument

Notional positions

foreign currencyforward or future

a long position denominated in the currency purchased

and

a short position denominated in the currency sold

Gold forward or future

a long position if the forward or future involves an actual (or notional) sale of gold

or

a short position if the forward or future involves an actual (or notional) purchase of gold

Equityforward or future, or option (unless the interest rate PRR is calculated under the basic interest rate PRR calculation in BIPRU 7.3)

A long position if the contract involves an actual (or notional) sale of the underlying equity

or

A short position if the contract involves an actual (or notional) purchase of the underlying equity

BIPRU 7.3.2RRP
A firm'sequity PRR calculation must:(1) include all trading bookpositions in equities, unless:(a) the position is fully deducted as a material holding under the calculations under the capital resources table, in which case the firm may exclude it; or(b) the position is hedging an option or warrant which is being treated under BIPRU 7.6.26R (Table: Appropriate treatment for equities, debt securities or currencies hedging options);(2) include notional positions arising from trading
BIPRU 7.3.21RRP
If included in BIPRU 7.3's PRR calculation (see the table in BIPRU 7.3.3R), options must be treated as follows:(1) an option on a single equity must be treated as a notional position in that equity;(2) an option on a basket of equities or equity index must be treated as a future on that basket or index; and(3) an option on an equityfuture must be treated as:(a) a long position in that future, for purchased call options and written put options; and(b) a short position in that future,
BIPRU 7.3.45RRP
This rule applies to a firm that does not include a forward, future, option or swap on an equity, basket of equities or equity index in the calculation of its interest rate PRR calculation under BIPRU 7.2 (Interest rate PRR). However it does not apply to cliquet as defined in BIPRU 7.6.18R (Table: Option PRR: methods for different types of option). A firm must calculate the interest rate PRR for a position being treated under this rule as follows:(1) multiply the market value
BIPRU 7.4.4RRP

Table: Instruments which result in notional positions

This table belongs to BIPRU 7.4.2R(3)

Instrument

See

Forwards, futures, CFDs, synthetic futures and options on a single commodity (unless the firm calculates a PRR on the option under BIPRU 7.6 (Option PRR))

BIPRU 7.4.8R

A commitment to buy or sell a single commodity at an average of spot prices prevailing over some future period

BIPRU 7.4.10R

Forwards, futures, CFDs, synthetic futures and options on a commodity index (unless the firm calculates an PRR on the option under BIPRU 7.6)

BIPRU 7.4.13R - BIPRU 7.4.14R

Commodityswaps

BIPRU 7.4.16R - BIPRU 7.4.17R

A warrant relating to a commodity must be treated as an option on a commodity.

BIPRU 7.4.8RRP
Where a forward, future, CFD, synthetic future or option (unless already included in the firm'soption PRR calculation) settles according to:(1) the difference between the price set on trade date and that prevailing at contract expiry, the notional position:(a) equals the total quantity underlying the contract; and(b) has a maturity equal to the expiry date of the contract; and(2) the difference between the price set on trade date and the average of prices prevailing over a certain
BIPRU 7.5.5RRP

Table: instruments which result in notional foreign currency positions

This table belongs to BIPRU 7.5.3R(6).

Instruments

See

Foreign currencyfutures, forwards, synthetic futures and CFDs

BIPRU 7.5.11R

Foreign currencyswaps

BIPRU 7.5.13R

Foreign currency options or warrants (unless the firm calculates a PRR on the option or warrant under BIPRU 7.6 (Option PRR)).

BIPRU 7.5.15R

Gold futures, forwards, synthetic futures and CFDs

BIPRU 7.5.16R

Gold options (unless the firm calculates a PRR on the option under BIPRU 7.6).

BIPRU 7.5.17R

Positions in CIUs

BIPRU 7.5.18R

BIPRU 7.1.12RRP
A firm may calculate the PRR for a position falling into BIPRU 7.1.9R by applying by analogy the rules relating to the calculation of the interest rate PRR, the equity PRR, the commodity PRR, the foreign currency PRR2, the option PRR or the collective investment undertaking PRR if doing so is appropriate and if the position and PRR item are sufficiently similar to those that are covered by those rules.
BIPRU 7.7.2RRP
(1) A firm'sPRR calculation must include all trading bookpositions in CIUs.(2) A firm'sCIU PRR calculation must include all trading bookpositions in CIUs unless they are treated under one of the CIU look through methods and included in the PRR calculations for the relevant underlying investments or subject to an option PRR.(3) A firm'sPRR calculation for CIUs must include notional positions arising from trading bookpositions in options or warrants on collective investmentunde