Ask a number of knowledgeable options brokers if their clients should consider customer portfolio margining, and most will say yes. Yet relatively few options traders choose customer portfolio margining, even though it has been available since a 2006 change in SEC regulations.
Perhaps our reluctance can be likened to cooking in kitchens equipped with convection ovens, yet still baking the regular old way, using up far too much time and energy. In a similar way, our old-style Regulation T (Reg. T) accounts use up too much margin, some brokers believe. The percentage returns on our options trades, when measured against the buying power withheld while the trade is in effect, aren't as high as they might be.
In its Spring 09 "options central" newsletter, the Options Industry Council tackled the subject in an article by Todd Wilemon. It's possible to trade long calls and puts in a cash-only account, and Wilemon makes the point that options can't be purchased on margin. More complex options strategies require a margin brokerage account.
Wilemon explains that in Reg. T accounts, margin is calculated separately for each position, a strategy-based calculation. For any specific complex strategy, the brokerage employs a specific formula used to calculate the monies withheld. Wilemon terms customer portfolio margining a risk-based approach rather than a strategy-based one. "Multiple options positions in the same underlying security will therefore be allowed to hedge each other and the risk of the underlying position," he notes, since margin is based on risk. In customer portfolio margining, theoretical test prices above and below the current market are employed to each day to calculate the potential losses for all positions in a certain underlying. The tests are conducted on percentage moves above and below the current price levels, with those percentages varying according to the underlying's capitalization, type of underlying and other measures. That calculation often produces lower margin requirements than would be necessary in a Reg T account. Sometimes, it produces markedly lower margin requirements.
For comparison's sake, Wilemon employs the example of a purchase of 100 shares of a hypothetical stock for $91.50, together with a long protective JUL 90 put, purchased for $3.25. Under Reg. T rules, the margin requirement would be 50 percent of the stock purchase price and the total debit for the protective put. The total requirement would then be $4,900. He doesn't include commission considerations in his discussion. Under customer portfolio margining, the type of margining that he labels risk-based margining, the risk to the position would be the difference in the stock purchase price and the strike of the long put, multiplied by 100, plus the debit paid for the put. The total would therefore be $475 since the difference in the stock's purchase price and the put's strike is $1.50 or $150 for the 100 shares of stock.
Most brokerages will also provide you with examples comparing Reg. T requirements and portfolio margin requirements. BrokersXpress' FAQs page shows several. One, a collared IBM position, consists of 1,000 shares of IBM bought at $115.91, together with 10 125 calls sold for a credit of $3.90 each and 10 100 puts purchased for $3.90 each. In a Reg. T account, the position would require $57,955 in margin; in a portfolio margin account, only $8,835. Another position, a short strangle involving selling 100 IBM 90 puts for .65 and 100 IBM 125 calls for $3.90, would require a staggering $1,256,500 in margin in a Reg. T account but a more manageable $86,512 in an account with portfolio margining.
The benefit to options traders, particularly those trading complex strategies, is that less buying power or margin is tied up in trades, allowing for a greater percentage return on that buying power locked up in the trade. Tactics that might not be possible in a Reg. T account are sometimes possible in a customer portfolio margining account. Options traders have more leverage. Wilemon suggests that customer portfolio margining allows some active traders to operate in ways that only floor-based traders could operate in the past. The BrokersXpress FAQ's page noted that prior to the SEC's 2006 change in regulations, the prior pilot program had required accounts of "not less than five million dollars" before portfolio margining was allowed.
As with almost everything about options, pros and cons exist. With that extra leverage comes extra danger of ending up with a margin call one of these days. It might be easier to lose track of how much margin would really need to be available if there's an adverse market move.
Moreover, if a market move results in a margin call, only one day is allowed to meet that margin call with customer portfolio margining. In addition, to be eligible, Wilemon says an account must have a liquidating value of $125,000 or more. BrokersXpress, my broker, lists the requirement differently, saying that a "threshold equity requirement of $100,000 in minimum account value is required to be approved to use portfolio margining." Check with your broker to see what requirements are listed if you're interested in customer portfolio margining.
My broker also warned me that choosing customer portfolio margining puts restrictions on day trading above those in a Reg. T account. In fact, BrokersXpress's FAQ's page states baldly, "It is not permissible to engage in a strategy of day trading in a portfolio margin account." While I don't day trade per se any longer, I sometimes do trade in and out of long options positions that I'm using to hedge a complex strategy. For example, if I'm in 30 contracts of a RUT iron condor, and a move that's already somewhat overextended bumps the delta of my sold call up to 22-25 near the close one day, I'm likely to buy 2-5 long next-month calls to hold overnight. My intention is to hedge my delta risk in case there's a gap the next morning. I might or might not sell them the next day. Sometimes, over the course of a day or two when the market moves are adversely impacting my positions, I might buy and sell the hedging positions several times.
Choosing customer portfolio margining might restrict my ability to do that, although I haven't clarified if the interpretation has stayed the same and if, perhaps, a hedge in the same underlying would be treated differently from day trading an option in a different underlying. Those are points traders need to clarify with their broker before considering customer portfolio margining, especially for frequent day traders. That policy is obviously different than for a Reg. T account, where all that's needed is a trading account balance big enough to allow day trading.
I haven't changed to portfolio margining yet, although most other full-time traders who trade the size I do--typically at $75,000-$120,000 held in margin for each month's positions--have long since switched. With Reg. T accounts, I'm assured that I never owe more than I have in those accounts: I believe that the platform simply wouldn't let me enter an order than overextended the accounts. I wouldn't know that in a portfolio margining account, and that scares me, conservative as I am. Whatever decision I ultimately make, I've already invested lots of talking time with my broker and lots of thinking time, too. I suggest you do the same before making a decision.