Margin accounts provide a line of credit from the brokerage for additional purchases of securities. The additional buying power is commonly referred to as leverage, and leverage magnifies the returns in an account. Margin accounts also provide the ability to short sell securities.
Margin may be utilized in defined or undefined risk options strategies and provide immediate access to reinvest funds when a position is closed.
Margin trading has a greater potential risk of loss due to the use of leverage, interest expense from margin interest charges, and the possibility for margin calls in the event of a marked portfolio decline.
Regulation T by the Federal Reserve governs the use of margin in investor accounts. Reg T outlines the requirements for minimum initial margin and maintenance margin for positions in a margin account.
The minimum initial margin set by the Federal Reserve is 50%, and the minimum maintenance margin is 25%, although individual brokerage firms may require higher levels. To open a margin account, an investor must deposit a minimum of $2,000 or more, depending on the broker.
Portfolio margin utilizes margin requirements that incorporate the portfolio’s net risk, not just the risk of a specific position. Portfolio margin allows for significantly increased buying power in portfolios with robust hedging.
Margin requirements for portfolio margin are set based on a range of outcomes, such as a one standard deviation move up or down, or unrealized gains and losses of 10-15%.
Portfolio margin may be available for accounts with more than $100,000 of account equity and a minimum level of trading experience, such as three years. Investors utilizing portfolio margin typically must have the highest level of options authorization.