A margin account is a type of investment account that allows an investor to borrow money from the brokerage firm to purchase securities. This additional buying power is known as leverage, and it can amplify returns in the account. Margin accounts also enable short selling, which is the ability to sell a security that the investor does not own in the hope of buying it back at a lower price.
Reg T margin
However, margin trading comes with a higher potential for loss due to the use of leverage, interest charges, and the possibility of a margin call in the event of a marked decline in the portfolio value. The Federal Reserve regulates the use of margin through Regulation T, which sets minimum initial and maintenance margin requirements for positions in a margin account.
The minimum initial margin set by the Federal Reserve is 50%, and the minimum maintenance margin is 25%. However, individual brokerage firms may have higher requirements. To open a margin account, an investor must deposit a minimum of $2,000 or more, depending on the broker.
For example, an investor wants to purchase 100 shares of XYZ stock currently trading at $100 per share. If the broker’s initial margin requirement for shares of XYZ stock is the same as the Federal Reserve’s minimum Reg T margin of 50%, then the investor would need to have $5,000 as initial margin for the $10,000 purchase of XYZ stock.
Portfolio margin
Portfolio margin is another type of margin account that utilizes requirements based on the portfolio’s overall risk rather than just the risk of a specific position. This allows for increased buying power in portfolios that have strong hedging strategies. Portfolio margin requirements 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%.
One example of utilizing portfolio margin would be an investor who has a diversified portfolio of stocks, options, and futures. In a traditional margin account (Reg T), the investor would have to meet the margin requirements for each individual position, which can be restrictive and limit the potential returns. However, with a portfolio margin account, the investor’s overall portfolio is evaluated for risk, allowing for higher leverage and increased buying power.
Another example would be an investor who employs a strategy of selling options. In a traditional margin account, selling options can be a highly capital-intensive endeavor, as the margin requirement is based on the full potential loss of the option. With a portfolio margin account, the margin requirement is based on the overall risk of the portfolio, rather than just the risk of the option position, making it more favorable for option sellers.
To qualify for a portfolio margin account, an investor typically needs to have an account equity of more than $100,000 and a minimum level of trading experience, such as three years. Additionally, investors utilizing portfolio margin must have the highest level of options authorization.
It’s important to note that portfolio margin carries a higher level of risk compared to traditional margin account, as it allows for higher leverage. Therefore, it’s important for investors to fully understand the concepts and have enough knowledge and experience in trading before opening a portfolio margin account.
