The portfolio statistic that I keep my eyes most closely on is the "Available Funds," which is the difference between Account Equity and Account Margin Requirement. When Available Funds falls to zero, you get a margin call, and you have to liquidate positions whether you want to or not.
The August 31 summary statistics for the account I'm following on this blog are repeated below:
Cash: $ 12,287.18
Accrued Dividends: 82.70
Stocks: 110,606.66
Options: (8,939.31)
Account Value: $114,037.23
Equity: $122,995.54
Margin Requirement: 68,797.67
Available Funds: 54,197.87
Regulation T Margin Requirement: 94,941.99
Special Memorandum Acct: 43,637.69
Generally, if you are not borrowing money and you are not shorting any securities, you don't have to worry about margin. You can also sell covered calls without having to worry about margin.
The portion of my trading strategy that involves margin is selling naked puts, which also happens to be where I expect to make the best return on investment; covered calls, to my thinking, mainly serve to mitigate risk.
Anyway, if you are trading with margin, it's important to know how the margin requirements for your account are determined. There are legal requirements that must be met, but most brokerage firms will have additional requirements, and the ones that matter are those that your brokerage firm enforces. I'll review my broker's requirements, but be aware that there may be differences with your broker, and that the differences will not be subtle when it matters.
First, Equity is just the sum of Cash, Accrued Dividends, and Stocks and Bonds (in my case, just Stocks). There is a slight difference between this sum in the numbers above and the Equity reported, due (I believe) to differences in how bid-and-ask spreads are dealt with for Account Value purposes (which is where I took the basic numbers from) and for Equity purposes.
The margin requirements for stocks are 25% of the stocks' market value. For covered calls, the requirement is any in-the-money amount. To a certain extent, this doesn't make sense: for a stock trading at $100 with a covered call exercizable at $100 as well, the equity is $100 and the margin requirement is $25, for net available funds (equity less margin requirement) of $75; if the same stock goes up to $110 (the covered call remains exercizable at $100), the equity is $110 but the margin requirement is $27.50 for the stock and $10 for the covered all, for a total of $37.50 and net available funds of $72.50. So a stock with a covered call that is in the money (which is in fact a more certain position) adds less to available funds that a stock with a covered call that is exactly at the money.
Regardless, I don't make the rules, I just have to abide by them: the upshot of this for me is that I try to have my covered calls out-of-the-money in order to avoid the counter-logical hit to available funds. For Regulation T requirements, which include a margin requirement of 50% of market value for stocks, the hit is more severe: available funds for the covered call example above would go from $50 at-the-money to $40 in-the-money. More on Regulation T later.
The margin requirement for a naked put is the market value of the put plus the greater of (a) 10% of the strike price, (b) the strike price less 80% of the market value of the stock, and (c) $2.50. Items (a) and (b) together create a point of inflection at one-and-one-eighth (1 1/8 or 112.5%) of the strike price: if the stock price is above this, the margin requirement will be the market value of the put plus 10% of the strike price; if the stock price is below this, the margin requirement is the strike price less 80% of the market value of the stock. The latter situation is one I generally try to avoid: given that the market value of the put is also moving, the margin requirement is very volatile when is is based on the strike price offset by 80% of the stock's market value. I tend to open naked put positions such that the stock price is 125% of the strike price or higher, which gives some wiggle room before the margin requirement reaches this volatile situation.
Where the naked put strike price is less than $25, the item (c) $2.50 addition to the margin requirement will dominate the 10% of the strike price amount, so there will be a different inflection point, but otherwise the same considerations apply.
In addition to the regular margin requirements outlined above, an account using margin must also meet "Regulation T" requirements.* The Regulation T margin requirement calculations are the same as the regular margin requirement calculations except that the margin requirements for stocks under Regulation T is 50% of market value rather than 25%. This would normally make Regulation T requirements more restrictive than the regular requirements, but Regulation T requirements are applied differently: the "Special Memorandum Account" (SMA) is what really determines available funds under Regulation T, and this is determined on a daily basis as the minimum of (a) the current Regulation T margin requirement and (b) the SMA from the prior day adjusted by the Regulation T margin effects of any transactions within the account during the day. So basically, the SMA will never drop solely due to changes in market prices: it is locked in at a prior amount, subject to changes due to actual transactions in the account. It can, however, go up due to changes in market prices.
Also, note that because of the 50% margin requirement for stocks, Regulation T is a lot more lenient about naked put positions than it is about covered call positions, in spite of the fact that they are essentially identical: the change in value to a covered call position with a strike price of X will be exactly the same as the change in value to a naked put position on the same stock with a strike price of X.
* -- My brokerage firm allows a "Portfolio Margin" calculation to replace the Regulation T requirement if you elect it and if you keep your account equity above $110,000. I have not elected this, and my account equity is not so securely above $110,000 that I'd feel comfortable doing it at this point. Also, I don't mind too much that Regulation T reins me in from doing anything too stupid ...
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