What Is Portfolio Margin?

Portfolio margin refers to the modern composite-margin policy that must be maintained in a derivatives account containing swaps (including credit default swaps), options, and futures contracts. The objective of portfolio margining is to offset the risks to the lender through consolidating, or netting, positions to account for a portfolio’s overall risk. It 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 offsetting positions have been netted against each other.

For example, if a position in the portfolio is netting a positive return, it could offset the liability of a losing position in the same portfolio. This would reduce the overall margin requirement that is necessary for holding a losing derivatives position.

Key Takeaways

  • Portfolio margin is a set of risk-based margin requirements designed to offset risks to the lender by aligning margin requirements with the general risk of a portfolio.
  • Portfolio margin is utilized for derivatives accounts where long and short positions taken in various instruments can be netted against one another.
  • Often, portfolio margin stipulations result in much lower margin requirements for hedged positions than would otherwise be the case.

Understanding Portfolio Margin

Margin is the collateral that an investor has to deposit with their broker or exchange to cover the credit risk the holder poses when they borrow 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 been recently 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 margining requirements to more closely align portfolio margin amounts with the riskiness of a customer’s entire portfolio.

Portfolio risk is to be measured by simulating the impact of market volatility. This revised system of derivative margin accounting has freed up capital for options investors, allowing them more leverage, which previously was required for margin deposits under the old strategy-based margin requirements that were instituted in the 1970s.

Special Considerations

Margin accounts are also subject to regulatory requirements laid out by the Federal Reserve Bank’s (Fed) Regulation T, a package of rules that govern customer accounts. Additionally, the New York Stock Exchange’s Rule 431, Nasdaq’s Rule 2860, and the brokerage industry’s self-regulatory agency, the Financial Industry Regulatory Authority's (FINRA) Rule 721, govern how brokers manage margin accounts.

Among FINRA's requirements, broker-dealers who offer portfolio margin accounts must meet “specific criteria and standards to be used in evaluating the suitability of a customer for writing uncovered short option transactions,” and establish and monitor “a minimum equity requirement.” Broker-dealers must also monitor, report, and increase margin requirements on accounts with high concentrations of individual securities. Additionally, broker-dealers must provide customers with and receive their acknowledgment of, FINRA-approved written statements describing the risks involved in the accounts. Broker-dealers are also required by Securities and Exchange Commission (SEC) Exchange Act rules to segregate customer account assets from the institutions.