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Big Margin For The Masses: The Nuts And Bolts of Portfolio Margin

Margin trading has been around forever. But qualified traders, there’s another category—portfolio margin—that could take your leverage to new heights.

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8 min read
Photo by iStock

Key Takeaways

  • Learn the differences between traditional margin and portfolio margin
  • Understand how traders can qualify for portfolio margin

Being a snob is so last century. Especially in a trading context. Today, it’s about equality. Designer sneakers and super-high-tech sing-you-to-sleep watches for everyone who’s got the green. So what separates us retail traders from the pros? After all, we often trade the same strategies. We both have access to real-time data. We both have lightning-fast trade execution. In a word, we both have margin, which is nothing more than a difference in leverage.

Traditionally, for a given position in stocks and/or options, the professional trader usually has a lower margin requirement than a retail trader and thus, more leverage. The rationale for the retail trader’s higher margin requirement is that he or she doesn’t have the knowledge or ability to manage risk as skillfully as a pro. While that might have been true 10 years ago, retail traders are quickly closing the knowledge gap. That’s why “portfolio margin” was introduced in 2007 to let retail investors get closer to professional-grade margins.

Portfolio margin is a form of so-called “risk-based” margining, which can be a more efficient way to calculate options and portfolio risk.

Retail Traders Are People Too

Portfolio margin (PM), which can be applied to single real-time accounts whose net liquidity exceeds $125,000 (a TD Ameritrade requirement), uses an option pricing model to calculate the margin requirements of different strategies in an individual security—such as long stock, short puts, straddles, etc.as one aggregate position.

Here’s how PM stacks up against “regular” margin rules, which follow the Federal Reserve Board’s “Reg T” in determining the margin requirements for positions in margin, cash, and IRA accounts. Securities regulator FINRA also applies strategy-based rules for margin, cash, and IRA accounts, meaning each particular strategy has specific requirements. For example, the minimum to buy stock in a margin account is 50% of the value of the stock shares. To buy 100 shares of a $50 stock, for example, the Reg T margin requirement would be $2,500.

PM is different. With PM, the margin on the long stock would be based on what its largest theoretical loss would be if the stock rose or dropped 15%. That 15% is the minimum percent change for equities, but can be adjusted to a larger percent change if the risk of the stock or position warrants it. For example, a long stock position would have its largest loss over that +/- 15% range if the price dropped 15%. For the same long 100 shares of a $50 stock, a 15% drop would cause a $750 loss (15% x $5,000). So, the PM requirement would be $750. Portfolio margins are determined by a “stress test,” where the theoretical profit or loss (P/L) is calculated if and when the price of a stock or index drops or rises, and volatility drops and rises, by percentages determined by PM rules. The PM requirement is the largest theoretical loss across those various “stress test” scenarios on a risk array of price movement and percentages. In some cases, the PM real time can be much lower than the Reg T margin.

PM might sound complicated. But it’s actually pretty straightforward. Suppose the margin requirement for a vertical in stock XYZ is $A, a short strangle is $B, a long stock and covered call are $C. Under normal margin rules the total margin would be (A + B + C). But under PM, all these positions would be assessed together in its test. If some of the positions in XYZ have a theoretical profit when XYZ is down, they can offset theoretical losses on other positions in XYZ, and the PM requirement, as a result, can be lower.

Having a lower margin requirement for a position may sound great. But it also means being able to put on more, or larger, positions in your account. The downside of that, of course, is the risk of loss will increase with the additional leverage. And that might not fit your trading or investing style. So, if your account is above that $125k threshold, and you’re thinking about applying for PM, you need to go toward it with both eyes open and understand the products you are trading and the risk and reward of the portfolio.

One could argue, though, that extra margin buying power from a PM assessment can be also used to help diversify a client's portfolio, or to add protective or "hedge" trades to help shield the portfolio from a potentially large market or volatility move. 

Financial Democracy: PM In Action

Before getting into the dirty details of PM, you may be wondering how it all works. It starts with an options pricing model with these inputs:

  • Underlying price
  • Strike price
  • Time to expiration
  • Volatility
  • Risk-free interest rate
  • Dividend yield

For equities, the PM calculation theoretically moves the price of the stock up and down 15% and divides that range into 10 equidistant points. For broad-based equity indices such as the S&P 500 Index (SPX) and the Nasdaq 100 Index (NDX), the assessment range is down 12% to up 10%, and the range is divided into 20 equidistant points, in order to capture more price moves on the risk array. Then, for each price point in that range of scenarios, PM calculates the position’s theoretical value, and determines the position’s profit or loss (P&L) at those theoretical values. The largest theoretical loss across these scenarios is the PM requirement.

Let’s look at a couple of common options strategies and the difference between traditional margin and PM.

PM on a Short Put. In the world of traditional margin, say you were to sell short a naked 120 put for $0.80 credit on XYZ stock trading at $125. The Reg T margin would be nearly $2,000. Yet, in a PM account, the margin would be approximately $1,350. Let’s break down how that’s calculated. So, with the price of the shares down 15%, from $125 to $106.25, the put would have its largest theoretical loss of $1,350—thus, the PM requirement.

Margin Recap on Short Put:

Reg T = $2,000

PM = $1,350

PM on a Covered Call. How about a covered call with long stock and a short out-of-the-money call? Let’s say you want to buy 100 shares of a stock at $41.35, and short a 44 call at $0.35. In a margin account, the Reg T requirement would be 50% of the value of the stock—100 shares at $41.35 x 50%—minus the credit for selling the call. That’s $2,067.50 – $35 = $2,032.50. In a PM account, the loss when the stock is down 15% would be about $590. So, in a PM account, that would be the margin required to do that covered call.

Margin Recap on Covered Call:

Reg T = $2,032.50

PM = $590

Calculating PM Blindfolded

Remember: The PM requirement for stock and equity option positions is based on the +/- 15% stress test. But for options in broad-based indices like NDX and SPX, the PM requirement is based on a -10%/+12% stress test. There are different percentage ranges because some products are historically less volatile, and thus less risky, than others. Diversified indices tend to have lower volatility than individual stocks. Also, if your account has most of its risk concentrated in a single stock, a larger percentage range is used to determine the PM requirement. (Note that TD Ameritrade reserves the ability to hold higher margin requirements based on internal risk metrics.)

While it’s possible to calculate a Reg T margin for a simple position in your head, that’s not necessarily true for PM. TD Ameritrade implements what’s called a “concentrated logic expected price range” based on estimated maximum one-day price move on each individual security and may provide a higher percentage move to capture all of the concentrated risk. So while it’s not exactly a “secret sauce,” it’s got a lot of moving parts. 

Fortunately, you don’t have to crunch the numbers. But, you can get an estimate of what the PM requirement might be for a position even if your account isn’t yet approved for PM. The Analyze tab on the thinkorswim® platform lets you see the daily loss of a position across the range of PM percent changes below or above in the underlying stock or index. That will give you a real-time estimate of what the PM requirement might be.

For example, suppose you’re looking to short a put on the SPX in a PM account. You can use the Analyze page to simulate a short SPX put (see figure 1). Set the price slices on the Risk Profile to see the range for the SPX price on the Risk Profile.

Calculating PM

FIGURE 1: CALCULATING PM. Before you trade a strategy (naked put shown here), you can use the Analyze page on thinkorswim to calculate what your PM might be. Just open the Price Slices menu, set the slice range, and look for the point of the largest theoretical loss. For illustrative purposes only.

Then move your cursor between the -12%/+10% range to find the largest loss possible for that day. PM could reduce the margin requirement of those short SPX puts because of the way the algorithm computes a maximum theoretical loss. PM thus can give you more flexibility in strategy, in addition to lower requirements.

Want to do some "stress testing" of your own? Just below the Price Slices is a heading called Positions and Simulated Trades. There you can change the price of the underlying, roll the calendar ahead to any date you like, and even change volatility levels. These "what-if" scenarios can help you further assess your risk. 

The 99%: Who “Qualifies”?

So how do you get PM? First, you must have an account with a net liquidation value of at least $125,000. Now, you don’t have to close all your positions to have a PM account. You can simply have PM rules applied to an existing margin account (sorry, PM isn’t available for retirement accounts like IRAs). But your PM account needs to have at least $125K net liquidity for starters. Second, your account has to be approved for Level 3 trading (naked option selling). Last, take an online test—20 questions that explore risk and options strategies to let  TD Ameritrade know you understand enough about trading to feel comfortable granting you PM. With PM, it’s possible to put on large positions whose maximum risk is much greater than the value of your account. If a loss of that magnitude happens, it’s bad for everyone. And that’s why PM isn’t for everyone.

Now that you have a better idea of how PM works, is it right for you? Just because you have a PM account doesn’t mean you have to put on larger, or even more, trades. You naturally have the extra capacity to do so. But there’s no obligation. In that sense, having PM doesn’t hurt. And it may even be useful someday. So, take a look at your portfolio and trading styles. PM may give you some advantages you previously overlooked. And if it’s a tool you find beneficial over time, send the Founding Fathers a huge dividend check. Freedom for all means pro traders no longer get to hog the good stuff.

Important Points to Keep in Mind

  • To be eligible for portfolio margin, clients must be approved for writing uncovered options.
  • A margin deficiency in the portfolio margin account or sub-account, regardless of whether due to new commitments or the effect of adverse market movements on existing positions, must be met within three business days or may be due immediately because of market volatility.
  • Any shortfall in aggregate equity across accounts, when required, must be met within three business days.
  • Portfolio margin generally permits greater leverage in an account, which can create greater losses in the event of adverse market movements.
  • Because the maximum time limit for meeting a margin deficiency is shorter than in a standard margin account, there is increased risk that a client’s portfolio margin account will be liquidated involuntarily, possibly causing losses to the client.

The information presented is for informational and educational purposes only. Content presented is not an investment recommendation or advice and should not be relied upon in making the decision to buy or sell a security or pursue a particular investment strategy.
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Key Takeaways

  • Learn the differences between traditional margin and portfolio margin
  • Understand how traders can qualify for portfolio margin

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Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.

Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

For the sake of simplicity, the examples above do not take transaction costs (commissions and other fees) into account. For more information on commissions. You cannot directly invest in an index. Supporting documentation for any claims, comparison, statistics, or other technical data will be supplied upon request.

Portfolio margin involves a great deal more risk than cash accounts and is not suitable for all investors. Minimum qualification requirements apply. Portfolio margin is not available in all account types. Portfolio margin privileges subject to TD Ameritrade review and approval. Not all clients will qualify. Please consider your financial resources, investment objectives, and tolerance for risk to determine if it makes sense for your individual circumstances. Carefully read the Portfolio Margin Risk Disclosure Statement, Margin Handbook and Margin Disclosure Document for specific disclosures and more details. You may also contact  TD Ameritrade at 800-669-3900 for copies.

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