Chapters 17/18 Flashcards
Process of trading securities in the secondary market
- Order entry: The trade is placed either electronically or by using a paper ticket. The order entry is also referred to as the order memorandum.
- Execution: Once the ticket is filled, that trade is executed.
- Clearing: Once the trade is executed, the BD’s operations department clears the trade.
Brokers (Agents)
When a firm attempts to find the other side of the trade for its client. Brokers earn commissions for their services.
Agency cross
When a broker has one client looking to buy a certain security and another client looking to sell.
Dealers (Principals)
When a firm buys or sells securities to clients from its own inventory.
Market maker
A dealer that always stands ready to buy or sell a security and assumes risk by taking the other side of the trade.
Bid vs ask price
Bid: The price the market maker is willing to buy at.
Ask: The price the market maker is willing to sell at.
Ex: A market maker w/ a $20.00-$20.25 bid/ask is willing to buy at $20.00 and sell at $20.25. The $0.25 is the bid/ask spread.
Designated market maker (DMM)
The DMM maintains liquidity, promotes a fair and orderly market,
and resolves trade imbalances that result from a temporary lack of supply or demand in a particular security. The DMM must act as a dealer and trade from its own account.
Limit orders that are entered away from the market may be directed to the
designated market maker who will then place them in its book for the stock. From here, the DMM can act as a broker by arranging a trade for its clients, or act as a dealer by using its own inventory.
The DMM’s Book
Open limit orders may be accepted on the designated market maker’s book; however, market orders and not-held orders may not be accepted on the book
DMM Acting as an agent example
An investor gives a registered representative an order to buy 7,000 XYZ at 40.25. The order is transmitted to the firm’s floor broker, who enters the trading crowd and determines that the stock’s current quote is 40.50 - 40.75, 50 by 80. This means that the highest bid is 40.50 and the lowest offer is 40.75 with the bid representing 5,000 shares and the offer representing 8,000 shares. Although the floor broker is able to purchase
shares at a price of 40.75, this will not satisfy the conditions of the customer order. Therefore, the floor broker may leave the order with the DMM. Later, if the inside offer price drops to 40.25, the DMM will purchase the stock for the customer
DMM acting as a principal example
If the spread becomes too wide, DMMs are expected to enter the market for their own accounts and raise the bid or lower the offer to narrow the spread. Also, a fair and orderly market is indicated by a series of trades with small price changes (ticks) such as 40, 40.05, 40.10, 40.15, rather than large changes in price from trade to trade, such as 40, 42, 40.10, 41.75. The DMM is expected to supply stock to the market if there’s a large imbalance between supply and demand and may be required to sell short to accomplish this.
True or false: A DMM can compete w/ public orders?
False. Since a DMM may not compete with public orders, it may only
bid for stock higher or offer stock lower than the prevailing market price to reduce the spread.
Ex: If a quote is 40.00 bid and 40.10 offered, the DMM may bid 40.01 or higher and offer 40.09 or lower.
Stopping stock
When a DMM guarantees to execute a customer’s order at a specified price
DMMs can stop a stock for a public order but not for its own inventory
- Members are required to report to their customers that the order was stopped if
both members agree to the terms. - If an order is executed at a less favorable price than the agreed upon price, the member that agreed to the stop is liable for the difference.
True or false: Most debt securities trade on exchanges?
False, most debt securities trade OTC
NASDAQ market
The most famous dealer-to-dealer market. There can be many market makers for NASDAQ equity securities. The NASDAQ market is considered non-centralized.
- NASDAQ market makers must be open between 9:30amET-4pmET. Market makers are allowed to open their quotes either pre-market or post-market.
Firm quote
The bid and ask prices that market makers are willing to buy and sell at.
- It’s a violation for a market maker to fail to fill and order at the firm quote.
Backing away
When the market maker fails to fill and order at the firm quote.
Subject quote
When market makers provide a quote but it’s subject to change (not firm).
Workout quote
Provided when a client inquires about a block trade. This is done to indicate that before a firm quote is given, the client must be contacted again to ensure they’re still interested.
Unless a specific qualification is given, a quote is considered firm
Bid wanted (BW) vs offered wanted (OW)
BW= When a dealer asks a client to suggest a bid price
OW= When a dealer asks a client to suggest an ask price
How to be a NASDAQ market maker
A market maker must provide regular bid and ask prices, meet certain capital requirements, and be registered w/ FINRA. The market maker MUST always be ready to buy/sell 100 units at the bid/ask price.
- Transactions in NASDAQ securities must be reported within 10 seconds of execution.
Level 1 NASDAQ Access
Provides subscribers w/ the highest bid and lowest ask price for securities w/ at least 2 market makers. Typically used by member firms.
Level 2 NASDAQ Access
Provides subscribers w/ the entire order book: bids, offers, and quotation sizes for all of the market makers that enter quotes for each security.
Level 3 NASDAQ Access
Exclusive to market makers. Allows them to enter, modify, and cancel quotes, as well as confirm trades. Quotations appear immediately.
Inside market
The lowest bid and the highest offer price.
Ex: Market maker 1 has a bid/offer price of $20.00-$20.50 ; Market maker 2 has a bid/offer price of $19.50-$20.00; Maker maker 3 has a bid/offer price of $20.50-$21.00. The inside market is $19.50-$21.00.
OTC Market Group
A forum for OTC trading. The OTC Markets Group is tiered in 3 marketplaces:
1. OTCQX: The market place for established U.S. and global companies. Firms must have auditied financial statements, be registered w/ the SEC, and be current in their disclosures.
2. OTCQB: The market place for U.S. and international development-stage companies. Companies must be current in their SEC filings and undergo annual verification.
3. OTC Pink Open Market: All types of companies that are NOT required to be registered w/ the SEC.
- The OTC Market Group lists names and their contact info for market makers.
The Third Market
Exchange-listed securities traded OTC by large BDs and institutional investors. The prices of securities are often lower due to lack of commissions. The Third Market has grown in volume in recent years.
The Fourth market
Institution-to-institution trading. This does NOT require BDs.
Electronic communication networks (ECNs)
Essentially electronic brokers that match buyers and sellers. Charge a fee for the service. ECNs allow subscribers to trade during and after trading hours and do business anonymously.
Dark Pools
A system that provides liquidity for large institutional investors and high frequency traders but doesn’t disseminate quotes (hidden from the public- thus the name dark pools). The system may be run by exchanges OR BDs and allows trades to be anonymous.
- Allows investors to trade w/ the least amount of market impact and low transaction costs.
Gray markets
Stocks that are NOT exchange-listed and not actively quoted in OTC markets. This is often for companies who have recently been de-listed from exchanges. Gray markets may also be for companies about to IPO.
- There is very little liquidity in gray markets.
Consolidated Quotation System (CQS)
The electronic service that provides quotations for listed securities that are traded in markets outside of the primary marketplace where the securities are listed.
Ex: An NYSE security that also trades in The Third Market.
- OTC Market Group securities are not quoted on the CQS.
- Customers may specify which exchange they want their order executed. The BD does not have to accept the order, but if it does, it MUST follow the customer’s instructions.
Alternative Trading Systems (ATS)
SEC-approved non-exchange trading systems. ATSs are usually required to register w/ the SEC and FINRA as a BD, but NOT an exchange.
- Enhances liquidity in the marketplace.
Components of an order ticket
- Whether the order was a purchase or short sale
- Security name
- Date
- Quantity
- Terms and conditions (ex: limit order, day order, etc.)
- Account type (cash or margin)
- Whether discretion was exercised and whether it was solicited or unsolicited.
- Special directions to override standing instructions.
- Client identifier
- RR responsible for the account and BD
Flow of processing a transaction
- Order department: The department transmits buy/sell orders by allocating them to a specific exchange or product area.
- Purchase and sale department: Records the order and reviews it for any discrepancies.
- Margin department: Enforces customer account rules w/ regard to payment and delivery and maintains customer account records.
- Cashiering department: Where funds are received and disbursed.
- Reorganization department: Handles all post-settlement issues (ex: stock splits, stock dividends, etc.)
Long sale
Just the way STC or FINRA describes actually selling a security w/o the intent to buying it back at a cheaper price. This is different from short selling.
Reg SHO
A BD MUST locate the securities prior to a short sale to ensure they will be available for delivery by the settlement date.
Mitigates naked selling abuses
A broker-dealer may not accept an order to sell short an equity security for any person unless one of the following locate conditions is met:
- The BD has borrowed the security or entered into an arrangement to borrow the security.
- The BD reasonably believes it will be able to borrow the security when it’s due.
- Most BDs have easy-to-borrow and hard-to-borrow lists for customers and employees.
Market order
A trade order where the client accepts whatever execution price. The order is made immediately.
Fast market
A market w/ heavy volume and quickly changing prices. This can be because of a positive or negative event. In these types of markets, quotes can be delayed so customers who are price sensitive may benefit from limit orders.
Limit orders
Orders where customers specify what the price they want to trade at. A buy limit order may only be executed at the limit price or lower, and a sell limit order may only be executed at the limit price or higher.
Limit orders are often used for large orders in thinly or infrequently traded securities in which the customer feels that a market order will likely cause a temporary price fluctuation.
- If the limit order cannot be executed by EOD, they will receive a nothing done notification from the BD.
Priority of orders
- Market orders have first priority
- Limit orders are ranked by price
- Limit orders that are at the same price are ranked by when they were placed.
Stop order
A market order is activated when a stop price is reached. A stop order will always be filled so there is the risk that the price can fluctuate between when the order is activated and when it’s executed.
Sell stop order vs buy stop order
A sell stop order is placed below the current market price of the security. This is to mitigate any significant potential loss.
Ex: Stock A is currently trading at $30 and Investor A places a stop order at $25. Once Stock A reaches $25, the stop order is activated and the order must be filled.
A buy stop order is placed above the current market price of the security. This is to mitigate loss on a short sale.
Ex: Investor A shorts Stock A when it was $30. Now it is currently trading at $20. Investor A places a buy stop order at $21 to protect any profit.
Stop limit order
A stop-limit order is similar to a stop order in that if the market trades at or through the preset stop price, the order will be activated. However, once activated, a stop-limit order becomes a limit order and may be
executed only at a specified price or better.
W/ this, once the stop price is hit, the order may NOT be filled
Sell stop limit orders vs buy stop limit orders
Sell stop limit order= Placed below the current market price of the security in order to limit any potential loss. Once the stop price is reached, the limit order is activated and will only be executed if the price is above the limit price.
Ex: Investor A buys Stock A at $20 and enters into a sell stop order at $15. Stock A then trades at $15, the limit order is activated, but if the stock dips down to $14.99, the limit order will not be executed until it rises back to $15.
Buy stop order= Placed above the current market price of the security in order to limit any potential loss on a short sale. Once the stop price is reached, the limit order will only be activated if price is below the limit order.
Ex: Investor A shorts stock A when it’s trading at $20 and enters into a buy stop order at $25. Stock A then trades at $25, the limit order is activated, but if the stock rises to $25.01, it will not be executed until it reaches $25 again.
Day order
Unless otherwise specified, every order is a day order and will be executed if possible between the hours of 9:30amET-4:00pmET. If not able to execute, the order is cancelled.
Extended-hours exposure
Allows clients to be able to have their orders executed during extended hours.
Disclosures for clients wishing to trade exented-hours exposure orders
- Less liquidity
- Higher volatility
- Changing prices from the market close of the normal trading session
- Unlinked markets
- News announcements
- Wider spreads
Good-till-Cancelled (GTC) Orders/Open Orders
An order that remains in effect until it’s executed or cancelled.
At-the-open orders
An order to buy or sell at the opening price. If it’s not able to be executed at the opening price, the order is cancelled.
Market on close (MOC) order
A market order to buy or sell at or near the closing price.
Limit on close (LOC) order
A limit order to buy or sell at the close. Will only be executed if it’s at or better than the limit price.
Not-held (NH) order
An order that gives the BD discretion on when and at what price to buy or sell. An NH must be filled by the EOD or it will be cancelled.
Immediate-or-cancel order
An order that indicates that as much of the order as possible must be immediately executed. Anything that’s not executed is cancelled.
Fill or kill order
An order that indicates the entire order must be immeidatly filled. If it can’t, it must be cancelled.
All-or-none order
An order that indicates that the entire order must be filled, NOT necessarily immediately. If the entire order can’t be filled, it must be cancelled.
Reg NMS
NMS= National Market System
The regulation attempts to facilitate linked trading among the competing venues in order to provide customers w/ fair and liquid markets.
Quote Increment Rule/Sub-Penny Rule
A part of Reg NMS that prohibits quotes displaying prices in increments less than one penny, unless the stock’s value is less than a dollar.
Limit Order Display Rule
A part of Reg NMS that requires the market maker to display a customer’s quote within 30 seconds if the limit price improves the market maker’s quote. If the customer’s limit price matches the market maker’s quote and the market maker is at the inside market, the customer’s order size must be added to the market maker’s displayed size.
Order Protection Rule
A part of Reg NMS that prohibits the trading-through of a protected quote.
Ex: It’s prohibited to execute an order at a bid price of $34.20 on the NYSE if the bid price is $34.15 on NASDAQ.
- A trade-through occurs with an execution of a buy order at a price that’s above the lowest ask price, or the execution of a sell order at a price that’s below the highest bid.
- A protected quote represents the highest bid and lowest offer (i.e., the inside market) in a market center that allows electronic quotations. Manual (non-electronic) quotes are not protected by this rule.
Interpositioning
A prohibited practice where essentially there is a middleman between the customer and the best market and the middleman is detrimental to the customer. The prohibition does NOT apply if the member firm is able to prove that the 3rd party benefited the client.
True or false: Market makers can poste quotes in different markets at different prices?
False, market makes ARE allowed to post quotes in different markets at the SAME price.
Spoofing/Layering
A manipulative and prohibited act of bidding or offering a stock and then cancelling the order to artificially create buying or selling interest.
If the orders are placed at different prices, it’s considered layering
Front-running
When BDs or RRs place their own trades w/ prior knowledge of a block trade or large order that will positively impact their position. This is a prohibited practice.
Marking-the-close/Marking-the-open
When member firms place a series of trades right before the open or right before the close which either uptick or downtick a security. This is a prohibited act because it departs from the normal forces of supply/demand.
5% Markup Policy
A FINRA policy that states that BDs should NOT charge markups, markdowns, or commissions of more than 5%.
5% is merely a guideline, NOT a rule!!!
- This rule applies to both exchange-listed and OTC securities.
Factors considered when determining if a markup is excessive:
- The type of security involved
- The availability of the security in the market
- The price of the security: Markups generally increase as the price of the security decreases.
- The amount of money involved in a transaction
- Disclosure
- Pattern of markups
- The nature of the BD’s business
Proceeds transaction
When a customer directs a member firm to sell a security and use the proceeds of the sale to buy another security.
- Securities that require the delivery of a prospectus or offering circular are exempt from
the provisions of the 5% policy because these issues are sold at a specific public offering price. - For these types of transactions, the member firm must follow the 5% policy and compute the markup as if the customer had purchased the securities for cash and should add the compensation received on the customer’s sale to the compensation the firm received on the customer’s purchase. Essentially, the member firm cannot sum the sale and purchase to compute the markup policy.
Circuit breakers
Guidelines for when trading is halted. The market-wide halt is based on the S&P 500, and when the circuit breakers are breached, all stocks that trade on the NYSE and other exchanges are halted.
Guidelines:
Level 1- 7% decline between 9:30amET-3:25pmET: 15 minute halt.
Level 2- 13% decline between 9:30amET-3:25pmET: 15 minute halt.
Level 3- 20% decline any time: trading is halted for the remainder of the day.
Declines are based on the previous day’s closing value.
Reg T
Gives the Fed power to regulate cash and margin accounts. Although the regulation was created by the Fed, the SEC enforces the rule. For both long purchases and short sales of stock, the current initial Reg. T margin requirement is 50%.
Reg T determines the date by which payment is due for a transaction and the amount of credit that may be extended. The payment date is 2 days after settlement for both margin and cash accounts.
Marginable securities
- Securities listed on a registered stock exchange (incl. ETFs)
- Securities listed on the NASDAQ.
Non-marginable securities
- OTC equities
- Standard listed options
- IPOs (will become marginable once they’ve been held for 30 days)
- These securities can still be purchased in a margin account, just not on margin- must be paid for in full.
True or false: All clients are able to trade on margin?
False. Certain account owners cannot, for example, owners of IRAs, owners of custodial accounts, and owners of 401Ks.
Reg T Call
Short sellers are required to make their margin requirement no later than 3 days after the transaction. In certain cases, if the amount owed is $1,000 or less, the brokerage firm may choose not to issue the call and, instead, may add it to the amount of the loan in the account.
- A customer can meet the margin requirement by posting cash or marketable securities. If using securities, the MV of the securities must be twice the amount of the requirement.
Margin agreement
What customers MUST sign before opening a margin account.
Margin agreements are comprised of:
1. Credit agreement
2. Hypothecation agreement
3. Loan consent agreement (OPTIONAL)
Credit agreement
An acknowledgement that the customer is borrowing funds and must repay the full amount of interest and principal. The interest rate is usually variable and tied to the broker loan rate.
When a margin account is opened for a customer, the member firm must send the customer a statement that indicates the following:
- The conditions under which int. rates will be imposed
- The annual rates that may be imposed
- The method of computing interest
- How interest rates change and whether they can change w/o notice
- The method of determining the balance that interest will be charged
Hypothecation agreement/Pledge agreement
States that a brokerage can pledge the client’s margin requirement as collateral to receive a loan from a bank, so that the BD can lend to the customer to short sell.
Loan consent agreement
When a customer agrees to let the BD lend the securities in their accounts.
Margin Disclosure Document
- An investor may lose more funds than the amount deposited.
- The firm may force the sale of securities or other assets.
- The firm can sell the invetor’s assets w/o contacting the investor.
- An investor CANNOT choose which assets are liquidated when a BD liquidates to meet a margin call.
- The BD can increase their house margin requirement at any time w/o advance notice.
- An investor is not automatically entitled to an extention of time to meet a margin call.
Must be provided to margin clients at account opening & annually after
3 Balances Used for Computation in a Long Position in a Margin Account
- Long Market Value (LMV)
- Debit
- Equity
Long market value (LMV)
The current MV of the securities in a margin account. The MV of the securities must be marked-to-market each day.
Debit
The amount that a customer has borrowed and currently owes the BD. If there are no additional transactions, the debit balance will remain constant.
Equity
The investor’s ownership interest in the account.
Equity = Long MV + Debit
Excess Equity
Excess equity exists if the equity is greater than 50% of the market value. When the securities deposited into a margin account appreciate, the equity will proportionately increase.
Special Memorandum Account (SMA)
An account that tracks excess equity in a margin account. The SMA acts as a line of credit that WON’T go down if the MV of securities decline- keep in mind the BD wants to extend credit to earn interest.
Ex: If the MV of securities rises by $2k, the excess equity will be reflected in the SMA and increase the customer’s borrowing LOC by $2K. If the MV of securities decline $3k from there, the borrowing LOC is still increased by $2k.
How different margin account events affect the debt and SMA:
- Dividends received on stocks: Decrease the debit by 100% of the amt. received and increase the SMA by 100% of the amt. received.
- Int. received on bonds: Decrease the debit by 100% of the amt. received and increase the SMA by 100% of the amt. received.
- Voluntary cash deposited by the customer: Decrease the debit by 100% of the amt. received and increase the SMA by 100% of the amt. received.
- Proceeds received from selling securities from the account: Decrease the debit by 100% of the amt. received and increase the SMA by 50% of the amt. received.
Withdrawing SMA as cash
An investor is generally permitted to withdraw 100% of the SMA
generated. If a customer does choose to withdraw cash, the debit balance will increase by the amount withdrawn. However, the withdrawal will also cause the equity in the account to decrease proportionately
Restricted account
Essentially the opposite of excess equity. A restricted account is where the MV of securities in a margin account decrease. This will not effect debit, but the decrease in long MV will decrease equity. The BD will NOT require excess funds to be deposited.
- Customers can still make new purchases when their account is restricted. They must still meet the 50% margin requirement.
Same Day Substitution
When an investor buys and sells securities during the same day in a restricted account. If the amount bought and sold is identical, no additional deposit is needed. If the customer purchases more than they sell, they must re-meet the Reg T requirement.
Ex: Investor A performs a same day substitution and buys $10k of securities and sells $5k of securities. This is a net purchase of $5k meaning they must meet the min. margin requirement of ($5k * 50%) = $2.5k.
- If the sale is greater than the purchase, the SMA is credited for 50% of the net proceeds.
What is the minimum maintenance requirement for long positions in margin accounts?
25% of LMV. A restricted account is one w/ equity that’s < 50%, but >= 25% of the LMV. If equity falls below 25% of the LMV, a maintenance call is issued and must be answered promptly.
Phantom SMA
If a margin customer intends to take a withdrawal from SMA, but the withdrawal causes the account’s equity to fall below the minimum maintenance requirement.
Initial minimum maintenance requirement for long positions in a margin account
The customer’s minimum required deposit is the lesser of $2,000 or 100% of the purchase price. This requirement may override the 50% Reg. T requirement for initial purchases that are less than $4,000.
When must the short seller repay the lender of the securities?
There is no set timeline, however the lender can demand the return at any time.
- If a cash dividend is paid on the borrowed stock, the short seller is responsible for paying the dividend to the lender.
3 Balances Used for Computation in a Short Position in a Margin Account
- Credit balance (CR)
- Short market value (SMV)
- Equity
CR - SMV = Equity
Shorts can only be done in margin accounts
Credit balance
The proceeds from the short + the margin requirement. Reg T still requires a 50% minimum margin requirement.
Short market value (SMV)
The current market value of the securities that have been shorted.
- Since the securities are being shorted, if the value decreases, equity will increase and the amount it decreases by will be credited to the SMA.
Minimum maintenance requirement on short positions
Industry rules set a minimum maintenance requirement for equity to be at least 30% of the SMV. If a client has a short account in which SMA exists, she may not withdraw SMA if the withdrawal brings the account below the minimum maintenance requirement of 30%.
Ex: Investor A shorts 100 shares of Stock A at $20. CR = ((proceeds = $20 * 100 = $20k) + (initial margin requirement = $20k * 50% = $10k) = $30k. SMV = $20k. Equity = $30k CR - $20k SMV = $10k
If Stock A rises to $25/share, Equity = $30k CR - $25k SMV = $5k. (30% * $25k = $7.5k). Equity is currently less than $7.5k so Investor A must deposit $2.5k.
- In the event that the equity drops below the minimum, customers will receive a maintenance call for the amount that’s needed to bring the equity back up to the required amount.
Initial minimum maintenance requirement for short positions in a margin account
The greater of $2k or the required Reg T deposit.
Ex: Investor A makes an initial transaction in the margin account of a short of $1.8k. Although the minimum Reg T requirement is ($1.8k * 50% = $900), $2k is greater and thus must be deposited.
How to calculate equity in a margin account that has both long and short positions?
Equity = LMV + CR - DR - SMV
OR
Equity = (LMV - DR) + (CR - SMV)
Margin requirements for Treasuries
Maintainence and initial requirements range from 1% if the security has 1 year or less remaining until maturity OR 6% if the security has >= 20 years to maturity.
Margin requirements for munis
Maintainence and initial requirements are 7% of current MV.
Margin requirements for non-convertible corporate bonds
Investment grade: Maintainence and initial requirements are 10% of current MV
Non-investment grade: 20% of current MV OR 7% of principal, whichever is greater
Margin requirements for convertible corporate bonds
Maintainence and initial requirements are 50% of current MV
Short against the box
If a client is long and short an equal number of shares of the same security, the maintenance requirement is 5% of the long position.
True or false: Newly issued securities can be purchased on margin within 30 days of the issue?
False
True or false: Registered investment company shares can be bought on margin?
False
Leveraged ETF maintenance requirements
These products have special maintenance requirements that exceed the typical SRO minimum thresholds of 25% on long positions and 30% on short positions. It can be computed by multiplying the portfolio leverage factor by the SRO requirement.
Ex: What’s the maintenance requirement for a customer who has made a $1mm purchase of a 2x Long Gold Index ETF?
(2 * 25%)= 50% * $1mm = $500k
Ex 2: What’s the maintenance requirement for a customer who has a $1 million short position of a 3x Inverse Gold Index ETF?
(3 * 30%) = 90% * $1mm = $900k
Minimum equity requirements for pattern day traders
Pattern day traders have a minimum equity requirement of $25k. This required minimum must be deposited in the account before day trading activity begins.
Day trading margin calls
Day trading buying power is limited to four times the trader’s maintenance margin excess, which is determined as of the close of the previous day. If a day trader exceeds her buying power limits, she must meet a day trading margin call within five business days. During the time the margin call is outstanding, the account is restricted to buying power of two times maintenance margin excess.
- If the margin call is not met by the 5th business day, trading in the account is restricted to a cash-available basis for 90 days or until the call is met.
- Pattern day traders are NOT permitted to meet day trading margin requirements through the use of cross-guarantees. This includes accounts of different customers AND different accounts of the same customer.
Portfolio margining/risk-based margining
Portfolio margining is a risk-based approach to calculating margin requirements for a portfolio of securities, rather than relying on individual position-based calculations. The goal is to reduce margin calls. Portfolio margining allows clients to use a greater amount of leverage.
The requred margin is generally based on the greatest loss that may occur in a portfolio.
Strategy based margin considers the loss of each position separately
- The benefit of portfolio margining is that it permits clients to use a greater amount of leverage for a given amount of capital, provided the account is appropriately hedged.
- Long positions and short positions are NOT evaluated separately.
True or false: Portfolio margin is available to small retail investors?
False, portfolio margining is ONLY available to:
1. Any broker or dealer registered w/ the SEC under the Securities Act of ‘34
2. Any member of a national futures exchange where the index futures are hedged.
3. Any person approved to engage in uncovered options.
- If a customer intends to trade unlisted derivatives, the customer must maintain equity of at least $5,000,000 at all times.
True or false: If a portfolio margining account falls below the minimum maintenance margin, all calls must be met within three business days?
True
Portfolio margining disclosure requirements
- Portfolio margining allows for greater leverage which can lead to greater losses.
- Since a portfolio margining account has a short time period to meet a margin deficiency, the account may be liquidated if not met.
- Due to the extremely sophisticated mathematical calculations and theoretical values being used in portfolio margining, customers may not be able to predict the size of future margin deficiencies.
Operations professional
An employee of a BD who works in the back office.
