PORTFOLIO MARGIN and CROSS-MARGIN
AN OVERVIEW OF THE BROAD BASED INDEX
OPTION PILOT PROGRAMS FOR CUSTOMERS
Richard Lewandowski - Chicago Board Options Exchange
Portfolio Margin and Cross-Margin Pilot Plan Proposal
History
 Past and current margining of listed options and securities underlying
listed options .
 Studies of the 1987 market crash advocate cross-margining.
 “Report of the Presidential Task Force on Market Mechanisms”
(the “Brady Commission”)
 “The October 1987 Market Break” (SEC)
 “Working Group on Financial Markets” (Dept. of the Treasury,
FRB, SEC and CFTC)
 Net Capital - haircuts on options strategy based prior to April 1994.
 SEC no-action letter in April 1994 allows portfolio methodology.
 SEC changes Net Capital Rule in Sept. 1997 to formally allow
portfolio methodology as an alternative to strategy based
requirements.
 Proposed customer program will parallel haircut methodology.
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
History
 Since April 1986, OCC has utilized portfolio margin.
 Since 1988, Futures Commission Merchants (“FCM”) have applied a
portfolio (SPAN) margin requirement.
 Final changes to Reg. T (effective April 1, 1998)
 Permit portfolio margining as an alternative to Reg. T.
 Self-regulatory organization (“SRO”) rules needed to implement
portfolio margining
 SEC approval required.
 Portfolio Margin Committee formed - recommendations made.
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 Joint effort by CBOE, OCC, NYSE, AMEX, CME and CBOT to
implement portfolio margin system for customers.
 An alternative to the current “position” or “strategy” based margin.
 Pilot program initially.
 Limits a firm’s gross portfolio margin requirements to 1,000
percent of its net capital.
 Firms can select accounts as they deem appropriate.
 Participant criteria may be modified based on the pilot
experience.
 Plan also provides for cross-margin - margin requirement determined
using the same portfolio margin facility.
 Pilot will only permit portfolio margining of:
 Broad based U.S. listed securities index options
 Related exchange traded funds (i.e., SPDRS, DIAMONDS)
 Related index futures and options on those futures.
 No stock baskets permitted at this time.
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 Portfolio margining objective - determine margin based on potential risk
in a portfolio as a whole.
 Margin required is derived based on the greatest projected net loss in
an account given various scenarios of underlying price increases and
decreases and implied volatility changes.

Positions grouped by class.

Gain or loss on each position is calculated for assumed moves in the
underlying, both up and down.

Theoretical pricing formula is employed for options gains / losses.

Netting of gains / losses within class groups.

Offsets (gains) applied between classes, if eligible.

Greatest loss is the portfolio margin requirement for that class.

Total of class requirements is overall portfolio margin requirement.

Per contract minimum of $37.50 (.375 X $100 multiplier).

Firms can impose an “add-on” (house) requirement if desired.
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 Option theoretical
Corporation.

values
supplied
by
The
Options
Clearing
Provides for uniform margin requirements across broker-dealers.
 Broker-dealers organize customer positions into a firm or vendor
supplied spreadsheet.
 Portfolio margin requirement calculated within the spreadsheet
application using option theoretical values obtained from the OCC.
 Process is the same as is currently in place for computing haircuts
under the Securities & Exchange Commission’s capital rule.
 Market ranges for computing gains and losses:


high-cap broad based indexes --- +6% / -8% of the closing price of the
index
non-high- cap broad based indexes --- +/- 10% of the closing price of the
index
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 Portfolio margin computation done at close of each business day.
 Portfolio margin requirement is both the initial and maintenance margin
requirement - not necessary to determine whether an increase in the
requirement is due to a new commitment or adverse market moves.
 Margin call arises if requirement greater than net liquidating equity in
the portfolio margin account (cross-margin account).
 Margin call must be met by the end of business on T+1 (one day
settlement).
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 Liquidating or hedging to meet a margin call is allowed.
 Minimum Equity Requirement.




Account equity of at least five million dollars.
Accounts may be aggregated if same owner.
Not applicable to a broker-dealer, an affiliate of the clearing broker-dealer,
or to the cross-margining activity of a member of a national futures
exchange.
Firms may impose a higher minimum equity (house) requirement if
desired.
 Equity call must be met by T+3 (three business day settlement).

If equity call not met, no new orders may be accepted (except opening
orders that reduce margin requirement).
 Account guarantees prohibited (for equity or margin).
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 Required Disclosure

Firm must provide customer with a standard disclosure statement prior to
opening a portfolio margin and/or cross-margin account.

Customers must sign an attestation acknowledging that they have
received the disclosure document and are aware of the risks involved.

Not applicable to broker-dealers, affiliates of the clearing broker-dealer,
and members of futures exchanges.
 To offer cross-margining, a broker-dealer must:

also be an FCM and

either be a clearing FCM or have an affiliate that is a clearing FCM.
 Cross-margin account would be a securities account.

SEC customer protection rules and SIPC coverage apply.
 Internal risk analysis procedures required of each firm.
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Portfolio Margin and Cross-Margin Pilot Plan Proposal
Plan Overview
 CBOE filed a rule change with the SEC in January 2002 to go
forward with the pilot.
 NYSE filed a similar rule change with the SEC in May 2002.
 Final work to be completed before the pilot can begin:
 Customer Protection changes at the SEC and CFTC concerning
cross-margin account
 SIPC protection for non-securities products and balances in a
cross-margin account
 Hypothecation of customers’ long options positions at the clearing
house level (SEC)
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