- What does dollar option position from $$ strike \ price \times option \ unit \times multiplier $$ actually infer? Particularly for Digital Option.
- Do investment banks impose some kind of position limit on their positions?
- If yes, why should such limit exist, apart from Limit on Greeks and VaR?
- How does investment bank calculate its position size?
It infers the potential notional value of the underlying security assuming the option gets exercised. i.e. Strike price 100, Stock XYZ, 100 share multiplier. Notional Value of the option, if exercised, is 10,000. This is an amount you would need in an account if you chose to exercise your right as the option holder (margin not being considered for the sake of simplicity). All options are 'digital' nowadays.
IB's have constraints imposed upon them by regulators. IB's may also impose limits on customer accounts regardless of the size of the customer account.
Systemic risk. If you lived through 2008 and have heard of Lehman Brothers and/or Bear Sterns you should understand. IF not, Google has plenty of info on that.
They calculate in several ways. Notional position value is kept track of as well as net position value which is where the actual risk lies when dealing with exchange traded options that are cleared by an intermediary. They may also use more complex methods internally such as VaR.