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By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 16, No. 10 on June 1, 2007. 

On April 2, 2007, the final phase of the Portfolio Margin requirements for listed stock and index options went into effect. Any account approved for naked option trading is eligible to be granted these reduced margin requirements. Assuming that one’s broker has a real-time margining system, the minimum account size to be eligible for these requirements is $100,000; otherwise, it’s $150,000, with certain exceptions. Your broker can elect not to grant you these requirements (much as the broker doesn’t have to grant one exchange minimum margin requirements). However, for competitive reasons, we suspect most brokers will grant the requirements to eligible accounts.

Under Portfolio Margin, requirements no longer will be computed based on arbitrary parameters, nor not even necessarily on the maximum risk of the strategy. Rather, the risk of an option or stock position will be determined by evaluating the position at 10 equally-spaced intervals within a predetermined price range. The requirement will be the risk of the most adverse move. From the documentation, it is unclear what implied volatility is used to determine the option valuations, but it is likely the current implied volatility.

The movements are fixed, and not really volatilitybased1. The ranges are defined as:

  • +/-15% for stocks, stock options, stock futures, and narrowbased index options.
  • +/-10% for broad-based indices that are not high capitalization
  • +6%/-8% for high capitalization broad-based indices. There is a minimum requirement of $37.50 per contract.

Thus a naked $SPX put would be valued as if the underlying index had fallen 8%; a naked $SPX call would use a movement of +6% in the index. In either case, this is a lower requirement than the current naked margin requirement. Most positions involving naked options, especially ones such as reverse calendar spreads or reverse diagonal spreads, will have greatly reduced margin requirements under the new system.

Any truly hedged position (long stock, long put for example) will benefit greatly from this new computation, since the fact that risk is limited will be taken into account. Even a covered call write will have greatly reduced requirements since one is only forced to margin a decline of 15% in the stock price rather than putting up 50% of the stock price.

  Example: Suppose IBM is trading at 106 and one
  is considering a covered write on margin of the
  July 110 call, trading at 1.50.
  Old margin requirement: 50% of stock price (53)
    less option price (1.5) = 51.50 points
    ($5,150 per 100 shares), commissions not
  New margin requirement: 15% of stock price
    (15.90) less option price (1.50) = 14.40
    points ($1,440 per 100 shares).
  This is a large difference, and may just make
  covered writing on margin a viable strategy once
  again (the requirements for vertical spreads don’t
  drop nearly as much, in general).

While actual Portfolio Margin requirements are dependent on the specific stock price and its relationship to the striking price, we can make some general observations about which strategies will benefit the most from this change in requirements:

Most reduced: protective put, collar, short calendar (or other strategies involving buying near-term options and selling longer-term ones).

Potentially large reduction: long strangle, long straddle, especially if long-term options are used (the stock price movement assumptions are so big that the straddles and strangles appear to have little or no risk – an erroneous assumption that benefits long options unfairly).

Reasonably sized reduction: covered call, short longterm strangle, short index straddle, index condor, index naked option, short index strangle.

Smallest reductions: vertical spreads, long calendars, synthetic long stock.

Any other strategies not mentioned (such as naked equity puts) likely will fall between “smallest reduction” and “reasonably size reduction;” in other words, there will be some reduction, but not an extremely large one.

The lower minimum requirement (it used to be 10% of the underlying for naked options) will be beneficial as well. For example, if you sell a naked equity put whose strike is more than 15% out of the money – or if you sell any naked equity put and then the underlying makes a move to the upside of more than 15% – your requirement could be very small.

The CBOE has several memos and examples regarding Portfolio Margin requirement and calculations on its web site. Visit http://www.cboe.com/margin if you are interested.

Summary:Portfolio Margin gives one more leverage. Leverage is not necessarily a good thing or a bad thing. At our advanced seminars, we always stress the fact that leverage is within the trader’s control – one can allocate more than the minimum margin to any position and thereby reduce the leverage.


This article was originally published in The Option Strategist Newsletter Volume 16, No. 10 on June 1, 2007.  

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