Let's Talk About: Portfolio Margining
Ask And You Shall Receive...
Portfolio margining is undoubtedly one of the most popular subjects in our email in-box. We receive questions and comments about this confusing topic on an almost daily basis.
After being deluged by requests for information on this subject, we are happy to post the first in an extended series of articles on portfolio margining.
What Is It?
Before we discuss the nuances of portfolio margining, we should clarify the definition of the term "margin" in the options market. In the stock market, margin is defined as buying or selling equity on credit.
In the options market, however, margin takes on an added meaning. Options writers must also deposit margin funds to cover the cost of buying or selling the underlying assets of their options. In the case of cash-settled options, they must deposit sufficient margin to cover the settlement of their positions. With so many elaborate positions and scenarios possible in the options market, determining the proper requirements for margin deposits can be a tricky business.
The goal of the portfolio margining program is to revamp the method used to calculate margin requirements in the options market. In a nutshell, portfolio margining aims to redistribute your margin deposits to more accurately reflect the risk of your position.
The most significant benefit of portfolio margining derives from incorporating offsetting positions into your overall margin calculation. This should result in reduced margin, and therefore more free trading capital, for many options customers.
The Dark Days
Until recently, calculating margin requirements for customer accounts was a dark art that confused and angered many options users. This arcane practice often resulted in margin levels that bore little relation to the actual risk of a position.
Prior to the advent of portfolio margining, strategy-based margin was calculated using a rigid series of formulas. These formulas, most of which were designed in the 1970s, did not take into account offsetting positions and established set minimums for certain strategies. As a result, the strategy-based approach often required significantly greater margin deposits than were actually necessary to mitigate the risk of a position.
By tying up excess capital with needless margin deposits, this approach limited the trading activity of many options users and hampered the overall growth of the industry.
Continued in "The Battle For Margin"...
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