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11/16/2010

How Can I Relieve a Margin Call?


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There are three courses of action a trader can take to eliminate a margin call once it occurs: 1) add funds, 2) adjust positions, or 3) liquidate some or all of the trades in the account. Most will agree that depositing funds on short notice is the least desirable action. After all, if a margin call is triggered, it is probable that the account is suffering a draw down and throwing “good money after bad” isn’t a logical solution. On the other hand, if you did your homework prior to entering the positions in your account you likely have good reasons to believe that the market will eventually trade in your favor. One of the most mentally challenging aspects of trading is watching the market move in the manner that you had expected after trades have been liquidated. Failure to not benefit in an anticipated move is nearly as emotionally painful as being on the wrong side of a market and actually realizing losses.

Ideally, margin call avoidance is preferable, but even the most responsible traders will encounter the dilemma eventually. Rather than throwing in the towel and liquidating positions, or adding money to an already expensive market error, there is an unlimited number of ways to manipulate the exchange required margin by reducing the inherent risk of the trade. Naturally, lower risk equates to lower margin and in most cases lower profit potential, but for those who find themselves in a dire margin situation, beggars can’t be choosers. Before we delve into the details of adjusting margin requirements via position adjustments, we must first understand the mechanics of margin in a futures and options account. Futures margin is straightforward in that there is a concrete initial and maintenance margin requirement. The exchange will adjust these requirements from time to time, but for the most part they are straightforward.

Conversely, futures exchanges use a portfolio margining system known as SPAN to assess requirements in accounts that are holding option spreads or a combination of futures and options. For these traders, margin requirements are dynamic and are changing constantly. The specific parameters used by SPAN are a relatively closely held secret by its developer, the CME. Yet, understanding the basic premise will help you to determine how certain adjustments will impact your margin requirement. To do this, we look at position delta and the manner in which short options are treated in terms of margin.

–Carley Garner. Excerpted from Adjusting Margin and Risk: Tips and Tricks to Reduce Margin Requirements and Alleviate Margin Calls (FT Press Delivers Insights for the Agile Investor Series).


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