Explain the Process of “Socialized Losses” in a Derivatives Market.
Socialized losses occur when an exchange's insurance fund is completely exhausted, and the exchange must distribute the remaining deficit from bankrupt accounts among all profitable traders. This is typically done by proportionally reducing the profits of winning traders' open positions.
For example, if a deficit of $1 million remains, all profitable traders might see their unrealized profits reduced by a small percentage until the $1 million loss is covered. This is a highly undesirable and rare event that severely undermines trader confidence.
