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

Margin is a broad topic with many approaches, benefits, and risks. For qualified accounts, portfolio margin can be used to offset a measure of risk by consolidating—also known as netting—their positions to account for the overall risk of their portfolio.

Some experienced traders with well-diversified portfolios who are risk hedgers and use options as part of their overall trading strategy choose to use portfolio margin because it can translate to more buying power in their account. That can help create more opportunities to diversify or create a buffer when markets turn volatile.

But there’s always a flip side—lower margin requirements add leverage and risk. But if you want more investing flexibility with a margining system that’s more capital-efficient in calculating position risk, portfolio margin might be worth consideration.

Here’s a look at how portfolio margin works and what using portfolio margin might mean to an individual trader.

With portfolio margin, stock and options positions are tested by hypothetically moving the price of the underlying generally between +/- 15%. 

These price ranges are then divided into 10 equidistant points, and the loss or gain on the position as a whole is calculated at each of the 10 points. These 10 points are also called scenarios or risk array.

For broad-based equity indexes, such as the S&P 500® (SPX) and Nasdaq-100® (NDX), the range is divided into 20 equidistant points to capture more price moves along the risk array.

A portfolio margin calculation uses an industry-standard options pricing model and stress testing. Testing is done on a position’s implied volatility, and the margin requirement will be equal to the largest loss calculated for any given scenario. See figure 1 for an example of these margin requirements in 10 different scenarios.

For stock positions, a trader using portfolio margin is generally 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 (see figures 2 and 3). Hedging strategies are generally used to reduce, or hedge, risk associated with price movements in an underlying. For example, long 100 shares of XYZ at 134~ + long a 133 XYZ put is a hedging strategy that combines a long stock with a protective put, also known as a married put. 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 nonconcentrated positions.

How Does Portfolio Margin Account for Implied Volatility and Concentration?

Let’s start with implied volatility (IV), which is the amount of uncertainty or risk of changes in a security’s value. TD Ameritrade uses two methods to dynamically incorporate IV into the risk array:

• Sticky Strike (constant IV): Each options strike uses a constant IV in the options pricing model to calculate theoretical options 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 IV for the current price is not an 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.

Figure 4 shows examples of these methods.

Next up is concentration. TD Ameritrade uses proprietary logic to make this calculation. But before we get into the logic behind this process, let’s 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 a futures account or cross-product correlations.

If the PNR is outside of EPR, then the risk array will generally default to the TIMS (Theoretical Intermarket Margining system) minimum margin percentage. This applies to both up and down movement; 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.

Under the TIMS methodology, equity positions are generally stressed at plus or minus 15%.

If PNRs are outside of the EPR, then the house risk array is used, generally with TIMS percentages. Now, if the converse occurs, that is, when the PNR is inside 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 and EPR in the Explain Margin window for both portfolio margin and Reg T accounts (see figure 5).

What Does Portfolio Margin Mean for Traders?

On thinkorswim, you can see requirements and analyze current positions’ or simulated trades and positions as well as get real-time portfolio margin requirements.

Run Your Own Analytics?

You bet. Log in to the thinkorswim platform to access historical daily prices of securities. To do this, head over to the Analyze tab and turn on the thinkBack function, which allows you to view historical pricing, implied volatility, and the greeks. You can also analyze simulated or existing trades and positions using standard industry options pricing models. In addition, 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.

And finally, you can beta weight positions based on a benchmark, including the S&P 500 (SPX). You can calculate the 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 options test
• 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.

Portfolio margining involves a great deal more risk than cash accounts and is not suitable for all investors. Minimum qualification requirements apply. Portfolio margining is not available in all account types.

Use of portfolio margin involves unique and significant risks, including increased leverage, which increases the amount of potential loss, and shortened and stricter time frames for meeting deficiencies, which increase the risk of involuntary liquidation. Client, account, and position eligibility requirements exist and approval is not guaranteed.

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.

It is the client’s obligation to evaluate the risks of portfolio margin when making investment decisions. TD Ameritrade reserves the right at its sole discretion to decline a client the use of portfolio margin. In the event TD Ameritrade decides to terminate a client’s use of portfolio margin, the client’s account may be converted to the standard margin account. The conversion of a portfolio margin account to a margin account may require the liquidation of positions.