The Securities Litigation Expert Blog

How Portfolio Margin can Increase Leverage by 15X

Posted by Jack Duval

Find me on:

May 2, 2014 6:28:27 AM

This blog post continues our series on Portfolio Margin.

As we have discussed here, Portfolio Margining calculates the margin requirement for all positions related to an underlying equity or index.  This approach is risk-based because it considers the effects of positions that hedge each other.  A simple example, which will be examined below, is how a long stock position can be hedged by a long put on that stock.

The risk-based approach of Portfolio Margin is distinct from the traditional Regulation T (“Reg. T”) approach to initial margin.  Reg. T considers each position as discrete for margin requirements, irrespective of any potential hedging that may arise.  Risk-based Portfolio Margin is based on the net of all the estimated gains and losses in the portfolio derived from stress tests on a common underlying equity or index.

Stress Tests

A typical stress test is to consider the potential gains and losses in the combined stock and options positions in an underlying equity.   A common test is to examine how much the combined positions would move if the underlying equity had a plus or minus 15 percent move. The biggest net loss after combining the profit/loss of all the positions over the plus or minus 15 percent range would be the new margin for the securities related to that underlying equity.

Married Put Example

In this example, we compare the margin requirements under Reg. T and Portfolio Margin. Here we assume the following:

  • Purchase 1,000 shares of IBM at $190;
  • Purchase 10 IBM July 14 190 Puts at $6.5;

 

Security

Number

Price

Position Value

Initial Reg T Margin

IBM

1,000

190

190,000

(95,000)

IBM July 14 190 Puts

10

6.5

6,500

(6,500)

                                             Total Ret. T. Margin:   (101,500)

Security

Number

Price

Position Value

+/- 15% Stress Test

IBM

1,000

190

190,000

(28,500)

IBM July 14 190 Puts

10

6.5

6,500

21,700

                                        Total Portfolio Margin:   (6,800)

Explanation

Under Reg. T initial margin requirements, the stock and option position margins are calculated separately and then added to each other.  This results in a total strategy based margin requirement of $101,500.

Under Portfolio Margin, both positions are aggregated and the plus or minus 15 percent stress test is applied.  In the married put scenario, the maximum loss occurs if the stock dropped 15 percent. The $28,500 loss in the stock would be offset by the $21,700 (estimated) gain in the put.  The difference, $6,800, is the Portfolio Margin requirement.

In the married put example, a hedge fund (or other investor) is able to increase their leverage by approximately 15 times using Portfolio Margin.

Variation in Portfolio Margin

Portfolio margin varies from strategy to strategy and will increase with the amount of market exposure in the combined positions.  In the married put example the market exposure is low because the put is at-the-money, however, if the position was collared at plus or minus 10 percent, the exposure would be higher and so would the Portfolio Margin requirement.

Furthermore, the broker-dealer providing the Portfolio Margin may also impose their own house limits that are higher that the Portfolio Margin limits.  This is similar to house maintenance calls that are triggered before Reg. T calls.

In our next post in the series, we will examine the Portfolio Margin requirements for different strategies.

__________

For more information about Accelerant expert Doug Engmann, go here.

Get Updates on Portfolio Margin

Topics: leverage, Margin, Portfolio Margin

   

Subscribe to Email Updates

Recent Posts

Posts by Topic

see all