What is portfolio margin?
Portfolio margin refers to the modern compound margin policy that must be maintained in a derivatives account that contains swaps (including credit default swaps), options, and futures contracts. The goal of portfolio margin is to offset risks to the lender by consolidating or offsetting positions to account for the overall risk of a portfolio. Typically results in drastically lower margin requirements for hedged positions compared to traditional policy rules. Portfolio margin accounting requires a margin position that is equal to the remaining liability that exists after all the offsetting positions have offset each other.
For example, if a position in the portfolio is performing positively, it could offset the liability of a losing position in the same portfolio. This would reduce the overall margin requirement that is necessary to maintain a losing derivatives position.
- Portfolio margin is a set of risk-based margin requirements designed to offset risks to the lender by aligning margin requirements with the overall risk of a portfolio.
- Portfolio margin is used for derivative accounts where long and short positions taken in various instruments can be offset against each other.
- Portfolio margin stipulations often result in much lower margin requirements for hedged positions than would otherwise be the case.
Understanding portfolio margin
Margin is the guarantee that an investor has to deposit with his broker or exchange to cover the credit risk that the holder represents when he borrows cash from the broker to buy financial instruments, borrow financial instruments to sell them short or enter into a derivatives contract .
Portfolio margin requirements have only recently been instituted in the options market, although futures traders have enjoyed this system since 1988. The Chicago Board of Options Exchange (CBOE) imposes rules on margin accounts. In 2007, it introduced expanded margin requirements to more closely align portfolio margin amounts with the risk of a client’s entire portfolio.
Portfolio risk will be measured by simulating the impact of market volatility. This revised derivative margin accounting system has freed up capital for option investors, allowing them greater leverage, previously required for margin deposits under the old strategy-based margin requirements that were instituted in the 1970s.
Margin accounts are also subject to regulatory requirements set out by Federal Reserve Bank (Fed) Regulation T, a set of rules governing customer accounts. Additionally, New York Stock Exchange Rule 431, Nasdaq Rule 2860, and the brokerage industry’s self-regulatory agency, Financial Industry Regulatory Authority (FINRA) Rule 721, govern how brokers manage margin accounts.
Among FINRA’s requirements, brokers offering portfolio margin accounts must meet “specific criteria and standards to be used in evaluating a client’s suitability to enter into short discovered options transactions” and establishing and monitoring ” a minimum capital requirement “. Stockbrokers must also monitor, report, and increase margin requirements on accounts with high concentrations of individual securities. In addition, brokers must provide clients with and receive their acknowledgment of FINRA-approved written statements that describe the risks involved in the accounts. Stockbrokers are also required by the rules of the Securities and Exchange Commission (SEC) Exchange Act to separate assets from the accounts of clients of institutions.