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Portfolio Margin: How It Works and What You Need to Know

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August 5, 2016
Portfolio margins and option traders: how do they work?

In my last article on portfolio margin, I provided some background and history on this new type of margin and explained some of the differences between portfolio margin and Reg T margin. In this article, I’m going to explain how portfolio margin works and what using portfolio margin might mean to an individual trader.

With portfolio margin, stock and option positions are tested by hypothetically moving the price of the underlying between +/- 15%. At TD Ameritrade, large-cap, broad-based indices are tested with +10%/-12%. 

These price ranges are then divided into ten equidistant points and the loss or gain on the position as a whole is calculated at each of the ten points. These ten points are also called scenarios. 

The portfolio margin calculation uses an industry standard option pricing model and stress testing. This testing is done on a position’s implied volatility and the margin requirement will be the largest loss calculated for any given scenario. An example of these margin requirements under ten different scenarios is shown in figure 1.

FIGURE 1: EXAMPLE PORTFOLIO MARGIN REQUIREMENTS.

This table displays margin requirements, utilizing portfolio margin, under ten scenarios in the underlying stock. RBM represents the minimum requirement of $0.375 per option contract multiplier. Source: thinkorswim. For illustrative purposes only. Past performance does not guarantee future results.

For stock positions, a trader using portfolio margin is allowed 6.6 to 1 leverage. Importantly, trading with greater leverage involves greater risk of loss. Because of this, portfolio margin requirements are calculated in real-time.

It’s important to note that hedged positions may have lower margin requirements than unhedged positions as seen in figures 2 and 3. Hedged strategies are generally used to reduce, or hedge, risk associated with price movements in an underlying. For example, long 100 shares of XYZ at 106 + Long a 105 XYZ Put is a hedged strategy. Additionally, positions that are concentrated will be evaluated using a greater range in the underlying and the requirements on these positions will be greater in comparison to a non-concentrated positions.

FIGURE 2. EXAMPLE HEDGED STRATEGY

This table displays an example of a hedged position. Source: thinkorswim. For illustrative purposes only. Past performance does not guarantee future results.

FIGURE 3. EXAMPLE HEDGED STRATEGY IN PORTFOLIO MARGIN.

The table displays an example of a hedged position using portfolio margin. Source: thinkorswim. For illustrative purposes only. Past performance does not guarantee future results.

How does PM account for volatility and concentration?

TD Ameritrade uses two methods to dynamically incorporate implied volatility (IV) into the risk array:

Sticky Strike (Constant IV): each option strike uses a constant IV in the option pricing model to calculate theoretical option prices at each evaluation point of the risk array. This means IV does not change over each price slice.

Adjusted Sticky Delta (IV with slope): IV is based on the in-the-money/out-of-the-money amount of the options with respect to evaluation points. Then a slope and adjusted volatility is assigned to each price point.

But please note, the implied volatility for the current price is not adjusted Sticky Delta or Sticky Strike method. Of the two methods used, the risk array yielding the highest theoretical loss is applied for the margin requirements.

Examples of these methods are shown in figure 4.

FIGURE 4: EXAMPLE STICKY STRIKE AND STICKY DELTA.

This table displays margin requirements, utilizing portfolio margin, accounting for volatility and examples of stick strike and sticky delta. Source: thinkorswim. For illustrative purposes only. Past performance does not guarantee future results.

When it comes to concentration, TD Ameritrade uses proprietary logic to make this calculation. But before we get into the logic behind this process, let me define some terms used in the calculation. 

Expected Price Range (EPR) - The firm’s estimate of the maximum expected one day price range for a given underlying security. 

Point of No Return (PNR) - Percentage move in an underlying price in which an account will lose 100% of its equity (Net Liquidation Value =$0). Beyond this point, the account will become unsecured. PNR does not include equity in the futures account or cross product correlations. 

If the point of no return (PNR) is outside of EPR, then generally the risk array will default to the TIMS (Theoretical Intermarket Margining system) minimum margin percentage. This applies to both up and down, for example, if upside PNR is 60% and EPR is 50%, then margin will generally default to TIMS. Similarly, if downside PNR is -50% and downside EPR is -30%, then margin will generally default to TIMS.

Generally equity positions margin under TIMS the stress test applied is plus or minus 15%.

If PNR’s are outside of the EPR, then the house risk array is used, generally with TIMS percentages I wrote about in the first part of this series. Now, if the converse occurs, that is, when the PNR is inside of the EPR range, then a risk concentration exists and action is taken in real-time to increase the Portfolio Margin requirement. When concentration exists, the margin requirement will be set to the EPR. For example, if upside PNR is 30% and upside EPR is 40%, then the margin requirement will use 40% (EPR) to calculate the risk array even if the TIMS minimum may be 15%, for example.

The thinkorswim platform now includes PNR in the Explain Margin window for both PM and Reg T accounts as shown in figure 5. 

FIGURE 5: EXAMPLE POINT OF NO RETURN (PNR).

This table displays a PNR used in a portfolio margin calculation. Please note the risk arrays used for PM Margin Requirements may also be raised due to low liquidity and market events. Source: thinkorswim. For illustrative purposes only. Past performance does not guarantee future results.

What does portfolio margin mean for traders?

Now that you better understand how portfolio margin works, let’s discuss what it can mean for individual traders. Portfolio margin leads to a more accurate calculation of margin requirements than Reg T margin-fixed percentage and strategy rules. This means potentially more buying power.

With more buying power, portfolio margin gives traders more leverage. With this added leverage, it’s possible to increase diversification in an account, make more effective use of capital, and potentially capture market opportunities when conditions arise. 

In particular, traders who utilize options to hedge positions might benefit from portfolio margin requirements. 

The difference in buying power between a standard margin and a portfolio margin account is significant. You can learn more about these differences in the following video: 

https://tlc.thinkorswim.com/center/video/videos/Portfolio-Margin 

How can I analyze my portfolio margin requirements?

You can even see for yourself portfolio margin requirements in the thinkorswim® trading platform by TD Ameritrade.

You can analyze current positions portfolio margin or simulated trades and positions and get real-time portfolio margin requirements.

Run Your Own Analytics?

You bet. Log in to the thinkorswim® trading platform. You can access historical daily prices of securities on thinkorswim charts. Use the Scan tab to turn on the thinkback function, which allows you to view historical pricing, implied volatility, and the Greeks.

Or, head to the Analyze tab. You can analyze simulated or existing trades and positions using standard industry option pricing models. You can change components, including underlying price, increased/decreased volatility, time to expiration, interest rate, and dividend yield to calculate the theoretical price of the options and estimate portfolio margin requirements.

In addition, you can beta weight positions based on a benchmark, including the S&P 500 index (SPX). You can calculate percentage up/down to estimate the theoretical gains or losses on the portfolio. 

How can traders qualify for portfolio margin?

Portfolio margin is available to qualified TD Ameritrade clients who currently have a margin account and meet the requirements outlined below:

$125,000 in current equity

Full options trading approval

Must achieve a score of 80%, or better, on an option test

Clients can apply for a portfolio margin account. If approved, the account’s total Net Liquidated Value must remain above $100,000.

Along with the benefits of portfolio margin we’ve already discussed, approved clients receive 24/7 account support and free access to trading specialists for help with executing their strategies.

Get More with Portfolio Margin

Consider applying if you think portfolio margin is right for you. You must meet minimum requirements and have at least $125k in total equity.*