How Mark-to-Market Can Work For Derivatives

Kevin Cook, an options instructor for the Options News Network, argues that mark-to-market will work for derivatives. He suggests following the “LaSalle Street” model that has functioned smoothly in Chicago for over 160 years for the trading of commodity futures and financial exchanges. To begin trading derivatives on an open exchange he lists five criteria that need to be introduced:

1. Standardize size and terms of contracts so they can be traded freely and that risk transfer and price discovery are obvious.

2. A centralized clearinghouse must stand between buyers and sellers to ensure transparency and the enforcement of rules.

3. Twice daily mark-to-market would force risk management. This makes risk management a real-time, robust process, not an after-the-fact accounting guess.

4. Performance bond collateral is what every trader in Chicago must post, and it is a “good faith” deposit that is a volatility-based measure of the risk. It forces futures clearing member firms to mind the risk on all positions held in their customer accounts.

5. Liquidity and price discovery in an open market would make it possible for banks to avoid investing in illiquid assets.

Cook then closes his argument by citing the fact that over 160 years of futures trading history, no trading counterparty has ever lost money due to the failure of another.