What is Regulation T?
In the United States, Regulation T is available for accounts that have a minimum balance of $2,000.
When you sell naked options using Regulation T, it will reduce your available buying power by around 12% to 20%..
For example, if you sell one contract with a strike price of $100 it means that the notional value of that contract is $10,000 (since 1 contract is 100 shares).
If you’re trading Regulation T, then your buying power reduction is going to be anywhere from 12% – 20% of $10,000.
This means that your buying power will be reduced by $1,200 to $2,000 for every contract that you sell.
What is Portfolio Margin?
In contrast, Portfolio Margin is usually available to accounts with an account balance, or net liquidation value, of around $125,000 or more.
Overall, Portfolio Margin is more capital efficient than Regulation T and your buying power will be reduced by around 4% to 10% of the maximum loss.
Portfolio margin stress tests your entire portfolio in aggregate.
As a result, the further out of the money options that you sell, the less your buying power is going to be reduced.
This means that “PM”, or portfolio margin, looks at the risk of your entire portfolio.
Why should you use Portfolio Margin?
In my opinion, if you have an account balance of over $125,000 (the amount varies for each brokerage) then I believe it’s best to always use portfolio margin.
Tastyworks, E*Trade, Schwab and Interactive Brokers all offer portfolio margin for accounts over $125,000 – $175,000.
Portfolio margin works very well, especially when you’re disciplined, because it enables you to sell further out of the money options.
I remember when Amazon fell below $3,200 in late September 2021, during that time I sold put options on Amazon with a strike price of $2,200 or $2,300.
My buying power was only reduced by a few thousand dollars per contract, despite collecting around almost $1,000 for every contract that I sold..
Portfolio margin allows you to make less risky trades, and increase your win rate, without significantly reducing your available buying power.
You can sell further out of the money options and your trades will be more capital efficient when using portfolio margin.
Cons of Using Regulation T
Your premium collected as a percentage of buying power used is often significantly higher when using Regulation T.
Since Regulation T is less efficient, you may be encouraged to trade more aggressively and choose higher delta strikes so that you collect more premium.
This will lead to increased risk.
Major drawback of Portfolio Margin
One major drawback of using Portfolio Margin, particularly when trading naked options, is that during a large volatility expansion event, your excess liquidity tends to drastically decrease because many of your positions may get challenged at once.
As a result, it’s very important to make sure that you don’t trade too large and that you always leave an ample safety net.
If you trade too large, then you may be forced to close out your positions at an inopportune time.
As a result, you always want to ensure that you leave enough buying power to ensure that your portfolio can withstand a volatility expansion event.
Portfolio Margin allows you to take less risk by selling options farther OTM and still collect decent premium, without incurring a large decrease in your available buying power.
Oftentimes, even during periods of low volatility, traders can extend the duration of a trade, while going farther OTM, and make a trade using Portfolio Margin that wouldn’t be nearly as efficient if they made the same trade using Regulation T.
Also, Portfolio Margin allows traders to sell naked options much more efficiently than if they were using regulation T.
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