Portfolio Margin: What You Need to Know

March 6, 2024 Beginner
There are several levels of margin trading available to traders who qualify. Here we'll discuss the basics of margin trading, including how portfolio margin works.

Margin trading is a way to leverage a portion of an asset's cost to control a greater position.

However, beginning traders aren't usually able to immediately access margin. In general, traders start with a cash account, then, once they've been trading for a while and understand the risks, may move to apply for a margin account, and qualified traders can potentially gain access to a portfolio margin account. A portfolio margin account allows traders to secure up to 6.7 times the margin they'd be able to access in a "regular" margin account. However, trading with this much margin can feel awesome when things are going your way. When they're not, there could be serious consequences for your trading capital.

Here are different levels of accounts and what traders can expect with each.

Level one: Cash account

A cash account is generally used by beginning traders learning how to enter and exit positions. Because margin is borrowed money, some traders are more comfortable testing strategies and learning about risk management before using leverage in their trades.

With a cash account, traders can only buy shares according to their available cash. Profit and loss are calculated based on basic gains and losses after the trader exits the position. For example, say a stock is trading at $100 per share. The trader would need $10,000 to buy 100 shares. If the price goes up $5 and the trader sells their position, the profit is $500, minus any fees. If the price goes down $5 and the trader sells, they lose $500 on top of any fees. Without the cash, a trader would need to look for a cheaper stock or buy fewer shares.

Level two: Regular margin

Using the example above, a trader using the standard margin of 50% would need $5,000 in the account and would need to borrow the other $5,000 from their broker. Traders must pay interest on the amount borrowed. If the value of the stock drops, a margin call may be issued in the account. During a margin call, a trader is required to deposit more cash or shares in the account or it may be sold by the broker to cover the call amount.

Perhaps the trader also bought the 100-strike put option for $3 (plus transaction costs) on the same stock. The total margin would increase by $3 per share, or $300, plus transaction costs. The trader would need to provide $5,300. With a stock drop, though, the negative effects of margin could hurt the trader, although the value of the put could help offset some of that loss. Because of this risk, it's important for traders to have the appropriate risk management skills when trading in a margin account.

There are different ways to apply risk management. If a trader prefers charting and technical analysis, they could use support and resistance levels as guidelines to identify their entry and exit points, including stop levels. They could also change position sizes or hedge their positions with options.

Level three: Portfolio margin

Not everyone qualifies for a portfolio margin account. To be a permissioned portfolio margin client at Schwab, a trader needs at least three years of experience trading options and approval for writing uncovered options. An eligible trader must also achieve a score of 80% or better on an options test. Finally, each account must have full options trading approval and an initial value of at least $125,000 (smaller accounts can't be combined to meet this requirement). The account's total net-liquidating value must remain above $100,000. Finally, portfolio margin-permissioned accounts are only available for taxable (noncustodial) margin accounts.

When using the original example (buying 100 shares of stock plus an at-the-money1 put), in a permissioned portfolio margin account, a trader only needs to commit $300, plus interest. That leaves the trader with more cash to initiate new positions. However, if the accompanying put is sold or expires out of the money2 (OTM), the regular margin requirements on the stock apply.

It's important to remember that portfolio margin can magnify profits when the stocks a trader owns are going up. However, the magnifying effect can work against traders if the stock moves the other way as well.

In a portfolio margin account, the trader borrows a larger amount to control the same position. The higher leverage means a trader needs to be savvy in risk management and be aware of increased sensitivity to price changes.

One significant difference between a regular margin account and a portfolio margin account is that the funds a trader must allocate to their positions aren't based on individual trade risk but rather on total position risk. Stock and options positions are tested by hypothetically moving the price of the underlying. A trade that partially or wholly offsets risk in another trade may only require enough funds to cover the net risk instead of the sum of the individual risks.

The largest loss a position could theoretically have is calculated by an algorithm that determines how much a position might lose if the underlying price and volatility changes. Luckily traders don't have to figure it out by themselves, but they should know that when their options contract expires, it'll be either OTM or in the money (ITM). If it's OTM, then it's worthless and the trader loses the entire amount invested in the option. If it's ITM, it's worth its intrinsic value (the difference between the stock price and the strike price of the option). Traders will likely receive that value if they sell their long ITM options position before expiration (or pay that value if they buy to close their short ITM option). And what if they don't?

Chances are it'll be exercised (if they're long) or assigned (if they're short). ITM long calls and short puts result in the trader purchasing long stock. ITM short calls and long puts result in the trader selling the stock short. If a trader is long an option and the strike price is the same as the stock price at expiration, they can let their broker know if they intend to exercise the option. If they're short the option, then assignment will depend on what the long option holder intends to do.

Margin calls

Margin calls in a portfolio margin account can be issued anytime the account has fallen below the firm's margin requirements. To meet margin requirements, a trader can deposit cash or marginable securities, close existing positions to reduce the overall margin requirements, or open trades that would create cash or reduce margin requirements. Margin calls may have up to two days to be met, or they may be due immediately based on market conditions.

How to check a margin balance

Traders should review their maintenance excess (net liquidation value – margin requirements) periodically. On the thinkorswim® trading platform, select the Monitor tab, then Position Statement to see the buying power for an account. A negative buying power might indicate a margin call. A portfolio margin-permissioned account also allows the trader to review the buying power impact of a trade in the confirmation dialog box.

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.

1An option whose strike is "at" the price of the underlying equity. Like out-of-the-money options, the premium of an at-the-money option is all time value.

2Describes an option with no intrinsic value. A call option is out of the money (OTM) if its strike price is above the price of the underlying stock. A put option is OTM if its strike price is below the price of the underlying stock.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options" before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.

When considering a margin loan, you should determine how the use of margin fits your own investment philosophy. Because of the risks involved, it is important that you fully understand the rules and requirements involved in trading securities on margin. Please read the Margin Risk Disclosure Statement for more information.

It is the client's obligation to evaluate the risks of portfolio margin when making investment decisions. Charles Schwab & Co. (Schwab) reserves the right at its sole discretion to decline a client the use of portfolio margin. In the event Schwab decides to terminate a client's use of portfolio margin, the client's account may be converted to the standard margin account.  The conversion of a portfolio margin account to a margin account may require the liquidation of positions.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.