Option Traders: How Portfolio Margin Works

With portfolio margin, stock and options positions are tested by hypothetically moving the price of the underlying generally between +/– 15%.

These price ranges are then divided into 10 equidistant points, and the loss or gain on the position as a whole is calculated at each of the 10 points. These 10 points are also called scenarios or risk array.

A portfolio margin calculation uses an industry-standard options pricing model and stress testing. Testing is done on a position's implied volatility¹ (IV), and the margin requirement will be equal to the largest loss calculated for any given scenario. Below is an example of margin requirements in different scenarios in an underlying stock.

A trader using portfolio margin is generally allowed 6.6-to-1 leverage for stock positions. Importantly, trading with greater leverage involves greater risk of loss. Because of this, portfolio margin requirements are calculated in real time.

Hedged positions may have lower margin requirements than unhedged positions. Hedging strategies are generally used to reduce, or hedge, risk associated with price movements in an underlying. For example, long 100 shares of XYZ at 134~ + long a 133 XYZ put is a hedging strategy that combines a long stock with a protective put, also known as a married put. Additionally, positions that are concentrated will be evaluated using a greater range in the underlying, and the requirements on these positions will be greater in comparison to nonconcentrated positions.

The table below displays an example of a hedged position, or a long stock with a protective put.

This table displays an example of a hedged position using portfolio margin.

IV is usually incorporated into the risk array used in portfolio margin calculations. Schwab uses two methods to dynamically incorporate IV into the risk array:

• Sticky strike (constant IV): Each options strike uses a constant IV in the options pricing model to calculate theoretical options prices at each evaluation point of the risk array. This means IV does not change over each price slice.
• Adjusted sticky delta (IV with slope): IV is based on the in-the-money² (ITM)/out-of-the-money (OTM) amount of the options with respect to evaluation points. A slope and adjusted volatility is assigned to each price point. However, IV for the current price is not an adjusted sticky delta or sticky strike method. Of the two methods used, the risk array yielding the highest theoretical loss is applied for the margin requirements.

The table below illustrates both of these two methods.

Concentration is part of the calculation as well. Schwab uses proprietary logic to make this calculation. The two main terms used in this calculation include:

• Expected Price Range (EPR): The firm's estimate of the maximum expected one-day price range for a given underlying security.
• Point of No Return (PNR): Percentage move in an underlying price in which an account will lose 100% of its equity (Net liquidation value = $0). Beyond this point, the account will become unsecured. PNR does not include equity in a futures account or cross-product correlations.

If the PNR is outside of the EPR, then the risk array will generally default to the Theoretical Intermarket Margining system (TIMS) minimum margin percentage. This applies to both up and down movement. For example, if upside PNR is 60% and EPR is 50%, then margin will generally default to TIMS. Similarly, if downside PNR is –50% and downside EPR is –30%, then margin will generally default to TIMS.

Under the TIMS methodology, equity positions are generally stressed at plus or minus 15%.

If PNRs are outside of the EPR, then the house risk array is used, generally with TIMS percentages. Now, if the converse occurs, that is, when the PNR is inside the EPR range, then a risk concentration exists, and action is taken in real time to increase the portfolio margin requirement. When concentration exists, the margin requirement will be set to the EPR. For example, if upside PNR is 30% and upside EPR is 40%, then the margin requirement will use 40% EPR to calculate the risk array even if the TIMS minimum may be 15%.

The thinkorswim^® platform includes PNR and EPR in the Explain Margin window for both portfolio margin and Reg T accounts. The risk arrays used for portfolio margin requirements may also be raised due to low liquidity and market events. The table below displays the PNR and EPR used in a portfolio margin calculation.

On thinkorswim, traders can see requirements and analyze current positions or simulated trades and positions as well as get real-time portfolio margin requirements.

The thinkorswim platform offers access to historical daily securities prices. To access these prices, log in to thinkorswim, and under the Analyze tab, turn on the thinkBack function, which allows traders to view historical pricing, IV, and the greeks. It's also possible to analyze simulated or existing trades and positions using standard industry options pricing models. In addition, traders can change components, including underlying price, increased/decreased volatility, time to expiration, interest rate, and dividend yield to calculate the theoretical price of the options and estimate portfolio margin requirements.

Portfolio margin is available to qualified Schwab clients who currently have a margin account and meet the requirements outlined below:

• $125,000 in current equity
• Full options trading approval
• Must achieve a score of 80%, or better, on an options test
• If approved, the account's total net liquidated value must remain above $100,000

Approved clients also receive 24/7 account support and free access to trading specialists for help with executing their strategies.

Portfolio margining involves a great deal more risk than cash accounts and is not suitable for all investors. Minimum qualification requirements apply. Portfolio margining is not available in all account types.

Use of portfolio margin involves unique and significant risks, including increased leverage, which increases the amount of potential loss, and shortened and stricter time frames for meeting deficiencies, which increase the risk of involuntary liquidation. Client, account, and position eligibility requirements exist, and approval is not guaranteed.

Carefully read "The Charles Schwab & Co., Inc. Guide to Margin" for more details. For specific questions, please contact us at 877-752-9749.