If you’re an experienced options trader today’s show is for you, because this week we’ll be talking about portfolio margin and how it could help enhance your returns. Yes, portfolio margin isn’t for everyone (you’ve got to have at least $125k in equity to qualify and three years of experience trading options), but the ability to upgrade your margin account to this portfolio risk model is incredibly powerful.
With portfolio margin, your broker is assessing each new option trade risk on the overall portfolio impact vs. an individual basis that happens in traditional margin accounts. They are asking the question, “How much risk does this new trade add to the overall portfolio?” More often than not, it means less margin required for new trades when you’ve already got offsetting positions.
So, how does portfolio margin help? Well, when you have to put up less cash in margin to hold a position that takes in the same premium, it means you can generate a higher return and free up additional capital for more positions. Still, this fairy tale could also be a curse in disguise if you don’t manage your account properly.
In today’s show, you’ll discover how brokers “stress-test” positions based on percentage moves in the underlying stock or ETF, how they think about concentration risk, and how margin “kick-backs” could increase exposure even when you exit trades.
Key Points from Today's Show:
- The basics of portfolio margin is the idea that a broker is going to look at your account on a total portfolio risk basis when you add new trades, versus on an individual risk basis.
- As a general rule, when you use a portfolio margin account, you are typically going to see half of your margin being used when you trade stock, compared to a traditional margin account. This gives you more buying power to leverage more on stocks.
- When it comes to options, most brokers stress test the option position against theoretical scenarios to assess how much money the position loses at different intervals or stress tests.
- For the stress tests, they will assume the stock goes up 15% and down 15% in price. For less volatile ETFs they will account for the lower volatility by doing a scenario stress test of up 10% or down 12%.
- If you are using portfolio margin, err on the side of caution and use the lower end of the spectrum with regard to allocation — 1% per trade.
- Portfolio margin is not a one-size-fits-all. As soon as you get into the trade, your margin is not fixed at that level — it is only the initial margin that the broker requires based on your entire portfolio.
- Position concentration can increase your margin required. It is an exponential curve, as far as margin required, as you continue to increase the concentration in your account.
Portfolio Margin Examples:
- You've got two trades: a long position in gold and a short position in silver. That kind of pairs trade should have a net neutral effect in your portfolio, because gold and silver are going to generally trade in the same direction.
- So if you were to trade gold long and silver short, then your portfolio should have a net zero, or delta-neutral, impact, which is how they look at it with portfolio margin.
- When trading in a traditional marginal account, they will look at each of those trades independently, not together, which will require you to keep a lot more margin for those two trades, even though they have less overall portfolio risk.
- Say Amazon is trading for $740. If you do a short strangle on Amazon, 15-Delta on either end, the regular margin that would be required for this position in a regular account is $11,967.
- Now if you were trading in a portfolio margin account, because they will stress test Amazon against the 15% up or down move and how much money you could lose at that level, portfolio margin in this case, would only require you to hold $2,785.
- Even with risk defined trades like iron condors, and credit spreads, and butterflies, your margin requirement is going to be less. Because again, they realize that sometimes the impact of a big move up or down is not going to be as great as a traditional margin account would require.
