Understanding Portfolio Margin: How It Works, Types, and Examples

Portfolio margin is a contemporary composite-margin policy applicable to derivatives accounts that include swaps, options, and futures contracts. The primary goal is to mitigate risks to the lender by consolidating or netting positions, thereby accounting for the overall risk of the portfolio. This approach significantly reduces margin requirements for hedged positions in comparison to traditional policy rules. Portfolio margin accounting necessitates a margin position equal to the remaining liability after netting all offsetting positions.

Margin serves as collateral deposited by an investor with their broker to cover credit risk. It applies to scenarios where the investor borrows cash, borrows financial instruments for short selling, or enters into derivatives contracts. While futures traders have utilized portfolio margin since 1988, portfolio margin requirements were introduced to the options market more recently. The Cboe Global Markets (Cboe) implemented expanded margining requirements in 2007, aligning margin amounts with the overall risk of a customer’s entire portfolio. This revised approach to derivative margin accounting has provided options investors with increased leverage, freeing up capital previously tied to margin deposits under older strategy-based requirements from the 1970s.

Margin accounts are subject to regulatory requirements outlined by the Federal Reserve Bank’s (Fed) Regulation T and various rules from entities such as the New York Stock Exchange, Nasdaq, and the Financial Industry Regulatory Authority (FINRA). Broker-dealers offering portfolio margin accounts must adhere to specific criteria, evaluate customer suitability for writing uncovered short option transactions, and establish and monitor a minimum equity requirement. Furthermore, broker-dealers must monitor, report, and increase margin requirements on accounts with high concentrations of individual securities. Compliance with SEC Exchange Act rules mandates broker-dealers to segregate customer account assets from institutional assets.

Portfolio margin is a risk-based margining system designed for derivatives accounts containing swaps, options, and futures contracts. It aligns margin requirements with the overall risk of a portfolio by consolidating or netting positions.

Portfolio margin typically results in significantly lower margin requirements for hedged positions compared to traditional policy rules. The system allows for the netting of positions, reducing the overall margin needed for holding losing derivatives positions.

While futures traders have utilized portfolio margin since 1988, portfolio margin requirements were introduced to the options market more recently. In 2007, the Cboe Global Markets implemented expanded margining requirements to align with the riskiness of a customer’s entire portfolio.

Regulatory bodies, including the Federal Reserve, Cboe, and FINRA, impose rules and requirements on margin accounts. Broker-dealers offering portfolio margin accounts must adhere to specific criteria, evaluate customer suitability, and comply with various regulations to ensure proper risk management.

The revised derivative margin accounting approach associated with portfolio margin has freed up capital, allowing options investors to enjoy increased leverage. This contrasts with older strategy-based margin requirements that were in place since the 1970s.