Regulatio Ad Absurdum
Wed, Jan 20, 2010 | Frank C.
“Zealous men are ever displaying to you the strength of their belief, while judicious men are showing you the grounds of it.”—William Shenstone
An unexpected margin call the other day prompted me to dial up folks I know at a couple of brokerages and ask what the heck was going on. It appears that the political backlash against the financial industry is hitting us little guys: regulators are pressuring brokers to tighten margin requirements, and some of the restrictions they’re pushing are truly absurd.
Most option-savvy brokerages have long made customers put up margin on only one side of a two-sided spread such as an iron condor, butterfly or double-diagonal, where it isn’t possible to end up with a loss on both sides at the same time. It only makes sense—the margin is equivalent to the real maximum loss. If one side carries greater risk than the other, as in a broken-wing condor, the required margin is whatever’s needed to cover the larger maximum loss, not the sum of both sides.
But in their zeal to prevent financial institutions from taking excessive risks, industry regulators, I’m told, are leaning on brokerages to require additional margin on certain complex option positions. If the regulators have their way, your broker soon might have to demand as much as twice the amount of cash needed to cover the actual maximum loss on some positions. The double-diagonal is one strategy that sources say could be affected, as are broken-wing butterflies and condors. Oddly enough, no one I talked to seems to think the margin requirement will change for evenly balanced iron condors. Calendar spreads should be safe from any pointless increase in margin as well.
In any case, before you pick up the phone to register your disapproval with your broker’s friendly customer-service representative, you should know that the brokerages (the option-centric ones, at least) are on our side of this issue. The folks I talked to said their firms were not taking any action yet to change margin requirements as regulators are suggesting, and they seemed pretty confident that the industry would talk some sense into the bureaucrats before retail traders feel any impact from misguided efforts to protect us from non-existent risk. Let’s hope they’re right.
Home page photo courtesy of flickr user kongharald under Creative Commons license.
Tags: margin, regulation
January 20th, 2010 at 9:23 pm
Did that margin call stick?
Did the broker give you extra time?
This is frightening.
January 20th, 2010 at 10:16 pm
This surfaced with Double Diagonals at ThinkOrSwim on December 29th…a few of my friends were impacted by this change in margin requirements. Based on responses from TOS, it seems that even condors could be subject to this margin change if the wings are unbalanced.
-Dave
January 20th, 2010 at 11:22 pm
Mark – I didn’t mean to make this sound so frightening–the broker did give plenty of time to resolve the issue, and it went away automatically when January expiration freed up margin…consequently, I can’t say whether or not it actually did “stick”. But I’d be very surprised if any brokerage were to slam the door on its customers without fair warning.
January 21st, 2010 at 1:34 am
In Canada this ridiculous requirement has been in place for some time now. Every IC I place I must post margin for both sides. Brain-dead regulation has been happening here for years and the option brokers have done nothing about it nor provided more explanation than simply, ‘it’s Canadian securities regulations’.
January 21st, 2010 at 1:35 am
yes.. Tos requires more margin for many of the option trades.
We are trying to switch to portfolio margining
January 21st, 2010 at 10:01 pm
I recently tried to open account at major FCM, for option spreads on indexes. Emphasized that no naked options, ever.
After not getting any feedback on account opening status, I finally called to inquire. Credit is still evaluating the application.{ A polite way of saying, no.}
January 27th, 2010 at 4:11 pm
Would you get a lower margin requirement under this ‘regime’ for buying say a call condor for a debit than selling an iron condor for a credit as both positions synthetically equivalent … just a thought …. James
January 27th, 2010 at 7:58 pm
Apparently the regulators are focusing on unbalanced positions–positions with different numbers of contracts/leg or different widths between strikes, and perhaps different expiration dates (which is why double-diagonals might be affected). Ordinary (balanced) condors and butterflies don’t seem to be at issue.
For thinkorswim customers: Tom Sosnoff talked about this at the beginning of today’s Trader Lounge chat. The archived recording is available to TOS customers through their desktop client, under the “Seminars” tab in the “Support/Chat” window. The discussion of regulatory action goes from about minute 5:20 to about 13:35, with options-related issues beginning at about 8:00.