By KOPIN TAN, Barrons 20/08/2005 THIS FALL, MARGINS will be in the securities industry's spotlight. A bill making its way through Washington contains proposals sought by the futures industry that would effectively lower margins for trading stock futures. Because the U.S. futures market is overseen by the Commodity Futures Trading Commission, while the stock and option markets are regulated by the SEC, the option industry is lobbying for similarly reduced margins to apply to stock options. At issue is the question of how margins ought to be calculated. Currently, derivatives investors are required by their brokerage firms to deposit money into their accounts-since the options and futures they trade carry forthcoming obligations to buy or sell securities. Under existing rules, such margins are specific to each trade and security, and comes up to about 20% for options. Single-stock futures, which are jointly regulated by the SEC and CFTC, have margin requirements of 20%, while margin requirements for stock-index futures are between 5% and 10%. Critics say, however, that this rigid approach doesn't reward investors for diversification or risk management. For instance, an investor who buys puts to hedge against a pullback will have to furnish more margin than when he buys stock alone. Nor do margin requirements vary between, say, options on Google and Microsoft even though one stock is far more volatile than the other. The solution? Portfolio margining, which considers different long and short positions within an account to calculate its net risk, and which is a standard commonly used overseas. "It's the modern, capital-efficient way to quantify risk," says Peter Borish, chairman of OneChicago, the Chicago-based exchange for trading single-stock futures. While the precise monetary impact will vary from account to account, the overall margins required are expected to be lower for most customers. "It frees up a tremendous amount of the customer's capital, and should help attract more global investors," says Chicago Mercantile Exchange chairman Terry Duffy. [cboe] Not surprisingly, the futures market is pushing for portfolio margining to apply to stock futures, and such a provision is in the proposed Commodity Exchange Reauthorization Act of 2005, which would essentially extend the CFTC's regulatory authority and which Congress is expected to consider this fall. This has the option industry in a tizzy -- not because it opposes portfolio margining in principle, but because allowing it to apply to stock futures without granting similar privileges to stock options could create an uneven playing field for the derivatives markets. In a July 20 letter to the Senate, the six U.S. option exchanges argued that the proposal will destroy "regulatory parity" and provide "an unfair competitive advantage" to stock futures. "Given this disparity in margin levels, customers may choose security futures over security options not because of the merits of the product but merely because of its lower cost." Besides voicing their objection, the option exchanges likely will step up their own campaign to bring portfolio margining -- already available to professionals like market-making firms -- to stock-option investors. Last month, the SEC approved a pilot program, submitted some years ago by the Chicago Board Options Exchange and the New York Stock Exchange, which allows portfolio margining on a limited basis -- for options on broad-market indexes and exchange-traded funds, and only for customers whose accounts exceed $5 million. This raises hope, particularly as the futures market presses for new margin rules, for more liberal calibrations for stock-option traders. That can't happen, of course, without a nod from the SEC, widely seen as the stricter of the two regulators. It also remains to be seen how the SEC will regard a plea for more liberal rules. Several brokerage firms have pushed for portfolio margining, although a Securities Industry Association spokeswoman would say only that it's "reviewing these issues." An SEC spokesman declined to comment. With lower margins come greater investor responsibility and the need for more vigilant controls. After all, to reduce margins is to give investors more leverage to wield. "Greater leverage can mean greater risk," says David Kalt, chief executive of the online brokerage firm optionsXpress. "And for some retail customers, too much leverage isn't necessarily a good thing."
Thanks for bringing this article. It could be very nice to have SPAN margin system applied to stock futures and stock/index options...still in our lifetime
There are firms that offer risk-based haircuts. They just aren't open to retail clients. It's much like SPAN, except that you can cross margin between exchanges. For example, hedging CBOE options with CME futs. Cheers
It wouldn't happen under Donaldson. Under Cox it may have a shot. There are really several issues at work here. SSFs have never had a regulatory home and are suffering under the current 20% margin requirements. That needs to be addressed if SSFs are ever going to become viable. Broad based indexes and ETFs could get SPAN for the sub 5M crowd without seeming to cause any harm or hurting any competitive forces. Not all brokers are currently extending risk-based margin to their customers who should be receiving it. I think that has the best shot at becoming reality as there are no appreciable differences between these products and their commodity based counterparts. There may be some issues around granting Section 1256 treatment to additional products, which I believe is part of the same bill.
ktm, Could you provide a pointer to the part that deals with section 1256? I assume that wide-based indices are section 1256 contracts already and I'm interested in any new developments in this area. Thanks.
I haven't seen the text myself. I received an email from a contact that described some of the changes and Section 1256 expansion was mentioned in rough terms. I will inquire and see what I can find out.