‍

What is Regulation T (Reg T) Margin?

In investing and trading, Regulation T (Reg T) was created by the Federal Reserve System and refers to a set of provisions that instruct how much credit brokers can extend to customers to buy and sell securities. 

In stock trading, Reg T generally permits investors to borrow up to 50% of the purchase price of securities, with the remaining 50% funded with cash.

For short stock, Reg T requires traders to have 150% of the position value set aside when the short is created.

Reg T Example

For example, let's say you want to buy $10,000 worth of ABC stock but only have $5,000 in available funds. Reg T sets the initial margin requirement at 50%, allowing you to borrow the remaining $5,000 from your broker, effectively leveraging your $5,000 investment to $10,000.

So, why do brokers offer this feature? Because you pay interest on the borrowed funds, typically at a rate much higher than the risk-free rate.

If your margin rate is 12%, the borrowed portion of the underlying asset must return 12% annually just to break even on the margin portion of your trade. We can see this below:

Margin is great for short-term trading (particularly day trading) but generally unsuited for long-term investors.

What Is Maintenance Margin?

Maintenance margin is the minimum amount of equity an investor must maintain in a margin account after purchasing securities on margin. This requirement ensures that the account holds sufficient funds to cover potential losses and is typically set by regulatory bodies and brokerage firms. 

The broker typically sets this threshold, which can vary, but it often ranges from 25% (minimum) to 40% of the total market value of the securities.

Maintenance Margin Example

Let's now look at an example of maintenance margin in action, continuing with our $10,000 ($5,000 on margin) purchase of ABC stock.

• Initial Investment: You purchase $10,000 worth of ABC stock, using $5,000 of your own funds and borrowing $5,000 on margin.
• Maintenance Margin Requirement: Suppose your broker requires a maintenance margin of 30%. This means you must maintain at least 30% of the total market value of the securities in your account as equity.
• Threshold Calculation: 30% of $10,000 equals $3,000. Therefore, your equity (the value of your securities minus the borrowed amount) must not fall under $3,000.

Margin Call 

Now, let’s say ABC takes a tumble, and the market value of your stock slips to $6,000.

• Equity Calculation: Your equity would be $6,000 (current value) minus $5,000 (borrowed amount), equaling $1,000.
• Margin Call Trigger: Since $1,000 is below the required maintenance margin of $3,000, your broker would issue a margin call, requiring you to deposit additional funds or sell some securities to restore the minimum equity level.

If you don’t meet the margin call, your broker may choose to liquidate your account.

Margin and Options

Margin operates differently in options trading compared to stock trading. Understanding these distinctions is important before we get into portfolio margin. 

• Long Options: When purchasing options (calls or puts), you pay the entire option premium upfront. For example, if a call option costs $2 ($200 per contract), you must pay this amount in full from your cash balance; brokers do not extend margin for buying options because of the high leverage. ‍
• Short Options: Selling (writing) options requires a margin deposit because of the potential for significant losses. For instance, if you sell a call option on ABC stock, the stock's price could, in theory, rise infinitely. To mitigate this risk, brokers require you to maintain a margin in your account.
• Option Spreads: When trading defined-risk spreads (e.g., credit spreads, iron condors), margin requirements are significantly lower than selling naked options. Spreads involve both buying and selling options, where the long leg helps offset the risk of the short leg, and vice versa.

🧮 Check out our Option Calculator's here!

What is Portfolio Margin?

Portfolio margin evaluates the overall risk of your entire portfolio to determine margin requirements, which usually results in lower requirements than determining margin for individual positions. This approach allows for greater leverage and increased capital efficiency.

Portfolio Margin Example

Let's build on our previous example. Now, were going to add XYZ to our portfolio. We'll say both XYZ and our existing ABC position are highly correlated tech stocks.

You already have:

• ABC: $10,000 long position (using $5,000 cash + $5,000 margin)

Now you add:

• XYZ: $10,000 short position

Reg T Margin:

• ABC long (existing): $5,000 margin already in use
• XYZ short (new): 150% margin = $15,000
• Total margin needed = $20,000

Portfolio Margin: Your ABC long and XYZ short positions provide a natural hedge to one another (if the stocks are indeed correlated, a gain in one offsets a loss in the other), so since your broker sees you carrying less risk overall, they also provide a lower margin requirement.

Using portfolio margin, you may need only $12,000 for this trade (instead of Reg T's equity + margin total of $25,000), freeing up capital to invest elsewhere.

Reg T vs Portfolio Margin

The main difference between Regulation T (Reg T) and Portfolio Margin lies in their approaches to determining margin requirements. 

• Reg T: This traditional method sets fixed initial and maintenance margin requirements for individual positions, typically allowing up to 50% leverage for stock purchases. It doesn't consider the overall risk of your entire portfolio. ‍
• Portfolio Margin: This risk-based method looks at the risk of your entire portfolio and considers the correlation and offsets between positions. Examining your collective risk generally leads to lower requirements for margin and greater leverage than Reg T.

Portfolio Margin and Options

Option traders frequently use portfolio margin to reduce margin and increase leverage. Let’s take a look at a covered call example.

Position:

• Long 1,000 shares of ABC @ $150.00
• Short 10 ABC strike price 160 Calls @ $2.50
• Expiration date: January 21st
• Premium Received: $2,500 (10 contracts × $2.50 × 100)

Margin Requirements:

Portfolio Margin Requirements

To have your trading account considered for portfolio margin, you generally need to meet the criteria below: 

• Enabled margin account 
• Minimum account equity: $100,000 but usually higher for most brokers.
• Must apply through your broker and be approved for portfolio margin.
• Approval often requires experience in trading and an understanding of margin risks.
• Subject to ongoing monitoring.

Portfolio Margin Risks

As we learned, portfolio margin allows for greater leverage, which also means it carries greater risks. The additional risks of portfolio margin include, but are not limited to:

• Greater potential losses – With increased leverage, both gains and losses are amplified.
• Faster account liquidation – If margin calls aren’t met, brokers may liquidate your account. 
• Dynamic margin requirements – Unlike Reg T, where margin requirements are fixed, portfolio margin adjusts in real time. Sudden volatility can cause unexpected increases in margin requirements.‍
• Correlated risk exposure – In volatile markets, even historically positively correlated assets can move against each other unexpectedly. This can weaken or completely negate the intended hedge in a portfolio margin account, increasing your overall risk.
• Liquidity: Illiquid markets, particularly in options, can be very problematic for PM accounts.
  ‍

⚠️ When trading under portfolio margin, effective risk management is critical. While portfolio margin can lower margin requirements and increase leverage, it amplifies potential losses. Also, be mindful of commissions and fees not included in our aforementioned examples. Always understand the risks associated with portfolio margin and review The Characteristics and Risks of Standardized Options before trading options.

‍