Initial & Required Margin

The CVEX Protocol establishes margin requirements based on the expected loss of a trader's portfolio, quantified through the Value-at-Risk metric. This approach requires traders to maintain portfolio equity sufficient to cover the worst expected loss within a specified period and confidence level:

$$Required Margin=ExpectedLoss$$

To ensure that a portfolio's risk is adequately covered, the protocol calculates the equity of a trader's portfolio. This is the sum of the collateral provided by the trader in USDC plus the unrealised Profit and Loss (P&L) of each active position. The P&L for each position is calculated as the quantity of the position $n$ multiplied by the difference between the positions and the current $MarkPrice$ of the contract:

$$Equity=Collateral+\sum_{i=0}^n n_i(MarkPrice_i-EntryPrice_i)$$

Margin Ratio

To make margin requirements more comprehensible, CVEX introduces the margin ratio, which is the relationship between the required margin and the equity of the portfolio:

$$MarginRatio = \frac {RequiredMargin} {Equity}$$

A margin below 100% indicates that the trader's portfolio is sufficiently collateralised. If it exceeds 100%, the protocol initiates liquidation.

Example

A trader deposits $1000 as collateral and currently has an unrealised profit (P&L) of $200, making their total equity $1200. Their market position's net value is $10,000. The worst expected loss, as determined by the VaR model, is 9% of the position value, amounting to $900.

To calculate the margin ratio, the required margin ($900) is divided by the total equity ($1200), resulting in a margin ratio of 75%. This indicates the trader's portfolio is sufficiently collateralised under current market conditions.

Initial Margin

In addition to the required margin, the CVEX Protocol establishes an initial margin and an initial margin ratio:

$$InitialMargin=RequiredMargin(1+ConcentrationFactor)$$

$$IntialMarginRatio= \frac {RequiredMargin} {InitialMargin}$$

The initial margin requirement acts as a safeguard, preventing traders from opening positions that are initially at the brink of liquidation, ensuring there is enough buffer in the collateral to absorb minor price movements. Without this buffer, a small fluctuation in prices could instantly trigger liquidation in cases where the collateral is fully leveraged. The initial margin requires from traders to provide a safety threshold, preventing them from entering into overly risky positions that are highly susceptible to market volatility.

If a trader's margin ratio is below this initial margin threshold, they are restricted from withdrawing collateral or placing orders that further increase their margin requirements. However, they can execute orders that reduce margin requirements, including opening new positions that hedge existing ones in the portfolio. Thus, the interval between the initial and required margin delineates a scenario where a trader's portfolio is sufficiently collateralised. Yet, the trader is restricted from actions that would decrease this collateralisation.

Example

Continuing from the previous example, with a 25% concentration adjustment for the trader’s portfolio value, the initial margin becomes $900 + 25% = $1125. The initial margin ratio is $900 / $1125 = 80%.

Since the trader's current required margin ratio is 75%, below the 80% threshold, they can withdraw collateral or open new positions that might increase margin requirements. However, if the required margin ratio exceeds 80%, the trader must deposit additional collateral to open new positions or increase margin utilisation.

Concentration Factor

The initial margin includes a concentration factor, adjusting margin requirements based on the risk of open interest centralisation. Essentially, the larger the value of the trader's portfolio, the higher the initial margin requirement. This structure balances risks associated with liquidating portfolios that constitute a significant portion of the market's open interest.

The concentration adjustment factor is a multi-tiered dependency on the portfolio's net value. Platform operators configure the conditions of these adjustments to reflect current market conditions and effectively manage centralisation risks.

CVEX's approach to margin requirement calculation ensures that traders maintain sufficient collateral to support their trading activities, reflecting the risk profile of their portfolios. This method balances efficient capital utilisation and the imperative of shielding against market volatility, centralisation, and default risks.