Portfolio margin calculates margin requirements that take into account the potential risk of an investment portfolio. It takes a hypothetical price change for the underlying assets within a certain range, typically around 15%, and explores various scenarios. The price changes are then put on a ten-point scale, and the potential loss or profit on the portfolio is calculated for each point. With this method, traders adjust their positions to stay within acceptable risk limits.
What Is Portfolio Margin and How Does It Work?
11 Apr, 2023
At its core, a margin is a form of leverage – it is your broker allowing you a little bit of financial freedom to trade more notional value of a product than you have in the account, or it’s when your broker asks you to set aside a smaller amount than otherwise required if it is a cash secured position.
Margin trading involves borrowing funds from a broker to purchase any kind of financial asset. This allows you to increase your purchasing power and trade larger positions than you would be able to do with capital alone.
A portfolio margin is a special type of margin associated with stock trading. It comes with several advantages and risks, and the experts at Exolix are glad to share their knowledge. Being mostly a crypto-centric exchange platform, we know that you expect from us more news and guides related to cryptocurrency. And information about portfolio margins is not an exception – PM programs are used with all types of assets, including cryptocurrencies.
What Is Portfolio Margin?
Qualified accounts have access to portfolio margin, which is a risk-based margin system. Traders and investors can use portfolio margin strategies to mitigate a certain level of risk by consolidating their positions and assessing the overall risk of their portfolio. Unlike fixed percentage and regulatory margin strategy rules, portfolio margin calculates the real-time margin for options and stock positions based on their risks.
As for the official definition from Investopedia, a portfolio margin is a modern policy that must be met in a derivatives account that contains swaps (including credit default swaps), options, and futures contracts.
In crypto, portfolio margin programs are used to unleash cross-asset capital effectiveness and consolidate risk management. One of the largest programs was launched by Binance to support consolidated margin balances across futures and margins with over two hundred effective crypto collaterals, including COIN-M/USD-M Futures and Margin accounts. It is also only available for qualified (VIP 7-9) accounts.
How Does Portfolio Margin Work?
An important note: portfolio margin requirements are strict. If you are a newbie trader (no matter whether you use traditional or blockchain-based trading instruments), you won’t be allowed to use portfolio margin management tools. But it’s a good motivation to trade more and reach a new level, isn’t it?
Experienced traders who want to manage their exposure prefer using portfolio margin, as it is more effective in terms of capitalization when calculating positional risk. The logic is simple: you gain more purchasing power in your account, which leads to more opportunities for diversification and greater protection against market volatility. However, using lower portfolio margin requirements can also increase leverage and risk, so you need to be aware of the downsides.
A portfolio margin works by hypothetically changing the price of underlying assets within a certain range (around 15%) to test positions. Then, the price ranges are divided into ten equidistant points, and the loss or profit on the position is calculated in each of the ten points. These items are also called scenarios or an array of risks.
The use of portfolio margin can result in dramatically lower margin requirements for hedged positions compared to traditional rules. The portfolio margin requires the maintenance of a margin position equal to the remaining liability after considering all offsetting positions.
And one more thing to consider: trading with greater leverage involves a greater risk of loss.
Portfolio Margin Calculation
A portfolio margin calculation is a way to find how much money you need to have in your account to cover potential losses from your investments. You can use a standard options pricing model, along with stress testing. Stress testing means imagining different scenarios, such as “what would happen if the market suddenly goes up or down,” for example, if the market drops by 10% or 15%.
The margin requirement is based on the largest loss calculated for any given scenario – you can determine this by looking at the implied volatility of your investments. Implied volatility refers to the amount of uncertainty or risk of change in the value of an asset.
Portfolio margins account for implied volatility (IV) and concentration. There are two methods for dynamically incorporating IV – Sticky Strike and Sticky Delta. As for concentration (a way of measuring risk for an investment account), Expected Price Range (EPR) and Point of No Return (PNR) are used. EPR is the maximum expected one-day price range for an asset, while PNR is the percentage move in the price of a security in which an account will lose 100% of its equity. If PNR is inside the EPR range, then there is a concentration of risk, and the margin requirement will be set to the EPR.
When using portfolio margin for stock positions, traders use 6.6-to-1 leverage. Additionally, margin requirements may be lower for hedged positions than for unhedged ones.
Some brokerage firms offer portfolio margin accounts and provide tools and resources to help users calculate their portfolio margin requirements, but, as a rule, it’s not automatic, and it’s the trader’s responsibility to do the calculations. So, you should monitor all your assets, make transactions to change the portfolio, and convert the securities that are too risky to maintain a well-balanced set.
Frequently Asked Questions
Portfolio margining involves much more risk than cash accounts and is not the right choice for all market participants. To qualify for a portfolio margin, traders need to meet certain requirements set by the brokerage firm. They may vary from firm to firm, but here are the common criteria: From $100,000 to $500,000 in current equity; A trading approval; Certain experience in options trading; A high level of risk tolerance.
In short, a portfolio margin account is a type of trading account that allows you to use a more advanced method to calculate margin requirements for your investment portfolios. It is available only to experienced traders with qualified accounts. With a portfolio margin account, you can use a dynamic and risk-based approach that takes into account the overall risk of the portfolio instead of using a traditional method based on a fixed percentage of the assets’ value.