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According to John Gregory, "netted positions are inherently more volatile than their underlying gross positions". Given the context, I think he's talking about close-out netting and not payment netting.

I can't figure out why the netted position would be more (or for that matter less) volatile.

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  • $\begingroup$ For more context you can see the passage in Gregory's book Central Counterparties here books.google.com/… $\endgroup$
    – Alex C
    Sep 14, 2015 at 0:11
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    $\begingroup$ A number which is equal to the difference between two large positive numbers will usually be pretty volatile and erratic (or example it can easily change sign). Maybe it is as simple as that. $\endgroup$
    – Alex C
    Sep 14, 2015 at 2:40
  • $\begingroup$ I've read the text you linked to, unfortunately it didn't provide any further context than the quote I posted. (Even given your second comment) I don't see how the netted amount would be more volatile than the two positions it nets. If I have an exposure to you for $100 and you have an exposure to me for $50 making the netted exposure a positive $50 for you, how is that netted position more volatile than the two positions? $\endgroup$ Sep 14, 2015 at 17:02

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I think the easiest way to explain this is with an example of a spread trade. Consider a curve trade on WTI crude oil such that you're short 1y oil and long 2y oil. 1y oil is at \$50 and 2y oil is at \$54. You have one contract on each leg for a gross exposure of \$104k and net exposure of \$4k. If 1y oil moves up \$5 to \$55 and 2y oil moves up \$6 to \$60, your gross exposure is now $105k and your net exposure is now \$5k. Your gross exposure moved up ~1% while your net exposure moved up 25%. This is a crude (pun intended!) example of how netted positions can be more volatile than gross positions.

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  • $\begingroup$ Thanks, makes perfect sense now. Quick question, wouldn't gross exposure be 54 and 55 not 104 and 105? If i could, I'd give another +1 for the pun. $\endgroup$ Sep 25, 2015 at 0:51
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    $\begingroup$ Thanks! The gross exposure was off at the end there. After the market move it should be $115k (abs(-$55k)+abs($60k)). Hope that makes sense. It's the absolute value of the notional exposure of both sides. 1 contract of crude oil is $1000*price. $\endgroup$ Sep 25, 2015 at 5:30

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