The Securities Litigation Expert Blog

How Portfolio Margin can Increase Leverage by 15X

Posted by Jack Duval

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

Read More

Topics: leverage, Margin, Portfolio Margin

Understanding Portfolio Margin

Posted by Jack Duval

Feb 11, 2014 9:56:11 AM

This blog post begins a series about Portfolio Margin.

Background

Listed options trading was initiated on the Chicago Board Options Exchange (“CBOE”) in 1973 after a long approval process through the Securities and Exchange Commission ("SEC"). With listed options, investors had the opportunity to hedge underlying equity positions with an exchange traded product that could be carried in a brokerage account. In the early years of options trading, margins for both public investors as well as professional options market makers and specialists were treated similarly, based upon the individual positions of the options themselves rather than the overall relationships between the options positions and their underlying equities.

Risk-Based Haircuts

In the late 1980s, under pressure from the CBOE and the other options exchanges, the SEC approved a pilot project to test the efficacy of using "risk-based haircuts" ("RBHs") as the basis for calculating how much capital a professional options market maker needed to carry his or her portfolio of options and underlying equity positions in any given class of security.  Risk-based haircuts are based on the principle that positions which hedge the risk in other related positions in a given portfolio ought to be given credit when calculating the margin or capital requirement for that portfolio.

Sage Clearing Corporation was the options market maker firm selected to participate in the pilot because it was the only options firm calculating risk on a real-time basis at that time.[1]  After months of testing, the SEC approved RBHs for market-makers in 1990. 

Public Investors

While options market makers received the margin and capital relief for RBH in the early 1990s, public investors continued to be subject to margin requirements which looked upon their options and equities positions separately, irrespective of hedging.  These margin rules were modified over the years to grant limited, but not total, margin relief for certain strategies.  Similar to RBHs, these modifications took into account offsetting positions in options or between options and their underlying equities.

Portfolio Margin

Under pressure again from the CBOE and the options exchanges, the SEC agreed to allow another pilot project in 2005 to grant margin relief to sophisticated options investors and traders who carried offsetting options and equity positions.  These rules were similar to the RBH rules for options market makers. The SEC named this alternative margin regime "Portfolio Margining".

FIMAT Preferred was the only brokerage firm testing portfolio margin for the SEC from 2005 until 2007.[2] Subsequent to 2007, the pilot was converted to a final rule and currently a few dozen firms have qualified to offer portfolio margin to their customers.

_________

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

Notes

[1]           Accelerant expert Doug Engmann was co-founder and CEO of Sage at that time.

[2]           Accelerant expert Doug Engmann was CEO of FIMAT Preferred at that time.

Read More

Topics: leverage, Margin, Portfolio Margin

Puerto Rico Municipal Bond Crisis Research Links

Posted by Jack Duval

Oct 31, 2013 4:30:53 AM

For anyone doing research into the Puerto Rico municipal bond crisis, we have compiled a number of links that you might find useful:


We will keep updating this list.
Read More

Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, litigation, leverage, investments, links

UBS Puerto Rico Municipal Bond Funds Overview

Posted by Jack Duval

Oct 30, 2013 8:01:25 AM

It appears the crisis in Puerto Rico municipal debt has caught some leveraged UBS closed-end funds in the downdraft.  We took a quick look at the S&P Puerto Rico Municipal Bond Index and compared it to its domestic cousin, the NAV declines by fund since inception, and some summary data on the various funds.

For a high res PDF of the images embedded below:  UBS Puerto Rico Funds Overview.  We will have more later.

Below is a snapshot of the declines in the various UBS Funds:

 

Lastly, below is some some data on the UBS Puerto Rico closed-end municipal bond funds:

 

Read More

Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, litigation, leverage, investments

Subscribe to Email Updates

Recent Posts

Posts by Topic

see all