Portfolio margin is a way of calculating the margin requirements for derivatives traders using a composite view of their portfolio. Portfolio margin accounts offset investors’ positive and losing positions to calculate their real-time margin requirements. Portfolio margining may provide investors with lower margin requirements, allowing them to use more of their capital in trades.
Key Points
• Portfolio margin calculates margin requirements using a risk-based approach, potentially lowering requirements and freeing up capital.
• It assesses a portfolio’s risk, considering market volatility and theoretical price changes.
• Traders must maintain a $100,000 net liquidating value and get approval for margin trading.
• The Chicago Board of Options Exchange sets rules, and brokers use the TIMS model for daily risk assessment.
• Margin trading is risky and not recommended for beginners, but it can increase buying power for experienced investors.
Portfolio Margin, Defined
Portfolio margin is a type of risk-based margin used with qualified derivative accounts. It calculates a trader’s real-time portfolio margin requirements based on a risk assessment of their portfolio or marginable securities.
If a trader has a well-hedged portfolio they will have a lower margin trading requirement, allowing them to utilize more of their cash for trades and take advantage of more leverage. Of course the more margin a trader uses, the higher their risk of loss.
How Does Portfolio Margin Work?
Investors with qualified accounts where they trade derivatives including options, swaps, and futures contracts must maintain a certain composite-margin. Portfolio margin is a policy with a set of requirements that aim to reduce risk for the lender.
To determine portfolio margin, the lender consolidates the long and short positions held in different derivatives against one another. This works by calculating the overall risk of an investor’s portfolio and adjusting margin requirements accordingly.
The portfolio margin policy requirement must equal the amount of liability that remains once all the investor’s offsetting (long and short) positions have been netted against one another. Usually portfolio margin requirements are lower for hedged positions than they are with other policy requirements.
For example, the liability of a losing position in an investor’s portfolio could be offset if they hold a large enough net positive position in another derivative.
Margin vs Portfolio Margin
Here’s a closer look at how margin vs. portfolio margin compare when online investing, or investing with a broker.
Margin
Margin is the amount of cash, or collateral, that investors must deposit when they enter into a margin trade. Margin accounts work by allowing a trader to borrow money from their broker or exchange. By borrowing cash to cover part of the trade, an investor can enter into much larger positions than they could if they only used cash on hand.
Borrowing money, however, poses a risk to the lender. For this reason, the lender requires that traders hold a certain amount of liquid cash in their account to remain in margin trades. If a trader loses money on a position, the broker can then claim cash from the trader’s account to cover the loss.
Traditional margin loans under Regulation T require investors to put up a certain percentage of cash for margin trades based on the amount of the trade.
Portfolio Margin
Portfolio margin, on the other hand, calculates the required deposit amount based on the risk level of the investor’s overall portfolio. It looks at the net exposure of all the investor’s positive and losing positions. If a derivative investor has a well-hedged portfolio, their margin requirement can be much lower than it would be with traditional margin policies.
This chart spells out the differences:
| Regulation T Margin | Portfolio Margin |
|---|---|
| Maintenance margin = 50% of initial margin | Initial and maintenance margin is the same |
| Traders can’t use margin on long options, and long options have a 100% requirement | Traders can use margin on long options, and they can use long options as collateral for other marginable trades |
| Margin requirements are fixed percentages | Trader’s overall portfolio is evaluated by offsetting positions against one another |
| Margin equity = stock + (+/- cash balance) | Buying power (maintenance excess) = net liquidation value – margin requirements |
| Less flexibility on margin requirements | Broad-based indices allow for more leverage |
| Margin requirement is a fixed percentage of trade amounts | Stock volatility and hypothetical future scenarios are part of portfolio margin calculation |
Portfolio Margin and Volatility
Portfolio margin calculations take into account investing in volatile markets by factoring in the outcome of various scenarios.
Portfolio Margin Calculation
Calculating portfolio margin is a multi-step process. The calculation includes hypothetical market volatility and theoretical price changes.
The steps are:
1. Create a set of theoretical price changes across the trader’s margin account. These ranges may be different when trading options, stocks, and indices.
2. Divide the range and calculate the gain or loss on the overall position for each theoretical scenario.
3. Incorporate implied volatility into the calculated risk array.
4. Calculate the largest possible loss that could occur with each theoretical scenario. That amount is the margin requirement.
Recommended: Calculating Margin for Trading
Key Considerations
Portfolio margin can be a great tool for experienced investors who want to invest more of their available cash. However, there are some important things to keep in mind:
• Margin trading tends to be risky and is not recommended for beginning traders
• Traders must keep $100,000 net liquidating value in their portfolio margin account (this is not the same as a client’s margin account). If the account goes below this, they may lose their active trading positions and the ability to trade on margin.
• Traders must get approval to enable margin trading on a brokerage account before they can utilize the portfolio margin rules.
If an investor’s margin balance falls below the margin requirement, they could face a margin call, which would require them to either deposit more cash or sell securities in order to increase their balance to the required amount.
Portfolio Margin Requirements
The Chicago Board of Options Exchange (CBOE) sets the rules for portfolio margin. In 2006 it expanded margin requirements, with the goal of better connecting requirements to portfolio risk exposure. Reducing the amount of portfolio margin required for lower risk investment accounts frees up more capital for leveraged trades, benefitting both the trader and the broker.
Brokers must use the approved portfolio margin calculation model provided by The Options Clearing Corporation (OCC), which is the Theoretical Intermarket Margining System (TIMS). TIMS calculates the margin requirements based on the risk of the portfolio on a daily basis.
To remain qualified for portfolio margin, investors must maintain a minimum of $100,000 net liquid value in their account.
There are additional requirements derivatives traders should keep in mind if they use leverage to trade. Regulation T is a set of regulations for margin trading accounts overseen by the Federal Reserve Bank.
Brokers must evaluate potential margin traders before allowing them to start margin trading, and they must maintain a minimum equity requirement for their trading customers. In addition, brokers must inform traders of changes to margin requirements and of the risks involved with margin trading.
The Takeaway
Margin trading may be very profitable and is a tool for investors, but it comes with a lot of risk and isn’t recommended for most traders. If you use margin trading for derivatives, however, portfolio margin may free up more capital for trading.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
Photo credit: iStock/filadendron
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
SOIN-Q424-012