In the United States there are three types of margin trading accounts which are widely used. They are Regulation T margin, Portfolio margin, and SPAN margin.
Portfolio and SPAN margin accounts usually offer lower margin requirements, which can allow the possibility of larger leverage to your trading account.
Today we will discuss briefly some of the characteristics of these 3 margin accounts.
What is Margin?
Margin occurs when you as a trader borrow money from a broker. You will need a margin account to be able to make use of margin to trade. When margin is used, it allows you to purchase more of either the physical or the derivative of the underlying than you would normally be able to in order to perform your trade.
You must check with your brokerage firm to understand their specific regulations to determine their requirements for all margin accounts.
Let's discuss some of the pro and cons to each of the margining systems.
What is a Regulation T account?
Regulation T rules apply to stock and stock options
A Reg T or Regulation T account is governed by, and was created by the Federal Reserve Board. According to Investopedia.com, a Reg T account holder as “an investor may borrow up to 50% of the purchase price of securities that can be bought using a loan from a broker or dealer. The remaining 50% of the price must be funded with cash.” http://www.investopedia.com/terms/r/regulationt.asp
When you buy a security with monies borrowed from your broker or dealer, the term “buying on margin” is many times used to describe the transaction. You must deposit monies into your account to fund the additional capital required.
What is a Portfolio Margin account?
Portfolio margin is determined by a risk-based margin policy. The brokerage may require a test which you must pass to be able to obtain a portfolio margin account. The minimum account size may vary; it usually requires $125,000 in funds to open the account. Portfolio margin will usually allow the trader to trade with greatly reduced margin requirements verses using a Regulation T account. Portfolio margin accounts try to line up the margin with the overall risk of the entire portfolio of the traders account.
What is SPAN Margin?
SPAN rules are used to determine the margin required for futures and futures options. Certain qualifications are required by most, if not all, brokerage firms in order to obtain approval to trade futures.
The CME Group describes SPAN as follows:
“The Standard Portfolio Analysis of Risk (SPAN) system is a sophisticated methodology that calculates performance bond requirements by analyzing the “what-ifs” of virtually any market scenario.
SPAN evaluates overall portfolio risk by calculating the worst possible loss that a portfolio of derivative and physical instruments might reasonably incur over a specified time period (typically one trading day). This is done by computing the gains and losses the portfolio would incur under different market conditions.
At the core of the methodology is the SPAN risk array, a set of numeric values that indicate how a particular contract will gain or lose value under various conditions. Each condition is called a risk scenario. The numeric value for each risk scenario represents the gain or loss that particular contract will experience for a particular combination of price (or underlying price) change, volatility change, and decrease in time to expiration.”
Depending on market conditions, SPAN margin can give a trader the ability to enter a trade with less margin than a Regulation T Account. A SPAN margin account requires much less capital than the $125,000 which is many times required for a portfolio margin account. One broker that I am aware of will allow you to open a SPAN margin account for under $2,000 at the present time. Your brokerage can advise you their specific capital requirements in order to open a SPAN margin account.
SPAN margin accounts allow each exchange and clearing organization to determine their own degree of risk coverage.
In summary, SPAN and Portfolio margin accounts offer a potential reduction in margin requirements with increased account leverage. This could lead to greater risks as well as greater rewards. SPAN and Portfolio margin accounts assess the investors overall portfolio risk, which is based on the net exposure of all the positions. Remember, you as an investor must check with your brokerage to determine their requirements for the various margin accounts.
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Thanks for the article Joanna,
According to FINRA (see http://www.finra.org/industry/portfolio-margin-faq ) the minimum equity required is $100,000.00. Brokers can set their own higher minimum.
Great summary Joanna. We sometimes think we want PM margining without really understanding it. This helps a lot.