In the wake of the credit crisis, many regulatory agencies tightened their stances on investments. That proved true of FINRA, which terms itself "the largest independent regulator for all securities firms doing business in the United States." Prior to audits of clearing houses over the last few years, Reg T clients at different brokerages might have noticed quite different margin or buying-power effects from the same trade.

Reg T clients are those who have not elected or are not candidates for customer portfolio margining in their accounts. That's a hefty majority of retail traders, although more and more active traders who meet the qualifications are now choosing portfolio margining. As Steven Smith explained in a 2007 article upon the debut of portfolio margining, "the big difference is that strategy-based margining [Reg T accounts] looks and charges each position as a separate entity."

That looking at each position as a separate entity can result in some strange margining or buying-power effects. The difficulty is that FINRA employs rather rigid definitions of strategies such as butterflies and iron condors that require that each wing or side be balanced. If your butterfly or iron condor doesn't meet those rigid definitions, each side will be margined separately.

Let's look at an example to show you what I mean. Imagine that on Friday, April 15, 2011, with the RUT at 834.98, I decided to enter a 3-contract RUT MAY11 all-call butterfly centered at 830, and with the wings 50 points away. Think-or-swim returns a buying-power effect of $5,679.00 for this trade.

Imagine that I know that if the RUT was going to just climb steadily, volatilities would likely drop, and that drop was going to hurt the protective power of my long calls at 880. Perhaps I am more bullish than bearish and a little worried about that possible climb's effect. I decide to reduce risk by placing the upside wings closer than 50 points. I want to place them only 30 points away from the short options.

What happens? Bowing to FINRA's dictation that a butterfly strategy is only valid when the wings are of equal length, TOS and most other brokerages now must margin this trade as if it were two sets of spreads, a 3-contract 830/780 debit spread and a 3-contract 830/880 credit spread. Although the wing on the upside has been reduced to 30 points and risk is therefore less on that side, TOS calculates this uneven butterfly's buying-power effect at a whopping $16,140.00. Wow. Is the risk really greater than in the balanced 50-point butterfly?

I think not. Let's look into the numbers here and see if we can figure it out. Because the trade is now unbalanced, FINRA now requires the clearing house to calculate the buying power effect as if this were two separate spreads, as mentioned earlier. The debit for the 830/780 debit spread is $38.30. The cost for that would be $38.30 x 3 contracts x 100 multiplier = $11,490.

Now let's calculate the margin or buying-power effect of the credit spread. The credit spread theoretically returns a credit of $14.50 on the day I'm pricing it. The wings on that side are $30 apart, so the calculation of the buying-power effect of that side is as follows: ($30 - $14.50 credit) x 3 x 100 multiplier = $4,650.

Add the margin or buying-power effect of the two spreads and you get $11,490 + $4,650 = $16,140. That's 2.84 times the margin or buying-power effect of the balanced butterfly. Is your risk really 2.84 times higher? I would argue--as would many others--that it's actually less, at least on the upside.

Before you jump all over Think-or-swim, it's not TOS messing up. These are FINRA-dictated changes. Many of you have seen similar results for years with your brokerages. I know that when I traded butterflies on BX and elected to manage risk by buying back one of my sold options, my actual risk went down (fewer sold options) but my margin or buying-power effect went up.

Some brokerages and clearing houses are arguing with FINRA about those strict definitions of strategies. Until and unless their arguments are successful, those of us with Reg T accounts will have to live with this effect for a while, and when planning our butterflies, we have to remember that even adjustments that take off risk might result in a dramatically higher margin requirement. Never, ever use up most of your account's available margin to start a butterfly, as you may be making it impossible to adjust the butterfly. Buying back a sold option, closing out a few of the verticals and other such tactics will reduce risk and perhaps better manage the Greeks of the trade, allowing you to stay in long enough to collect a profit, but only if you have enough margin to do so. If you don't, you may be forced to close at a loss because you can't adjust.