Margin Requirements and Zero-Cost Factor Portfolios

[Begbie00]

I'm trying to understand how margin requirements (e.g. Reg T End-of-Day requirement of 50%) would constrain how much exposure I can take to a zero-cost factor portfolio (e.g. short-term reversal, momentum, etc.).

Say I have $2,000 in initial cash. Am I correct that I'd be constrained (via initial margin requirements of 50%) to a long/short factor portfolio that had ~$1,333 in long positions (e.g. momentum winners) and ~$1,333 in short positions (e.g. momentum losers) with this amount of initial cash?

Logic:
[zero-cost constraint] Long Position = Short Position
[balance sheet constraint] Equity = Remaining Cash + Long Position - Short Position
[cash-flow constraint] Remaining Cash = Initial Cash + Long Position - Short Position
[Reg T] Equity / Short Position >= 150%
therefore ... Initial Cash >= Short Position * 150%

Related: if the above is correct, it seems very tough to implement profitable factor portfolios given the large amount of cash required for margin unless you're earning interest on the cash (e.g. it wouldn't make any sense for someone with only $2,000, who would earn nothing on the cash at IBKR but have to pay stock borrowing fees on the shorted stocks). Is this a correct conclusion?

 

[Ayn Rand]

Your problem is that you only have $2,000 in cash. Few do much with so little.

 

[Begbie00]

$2000 is, I believe, the IBKR min. So I used it. But is the logic right?

 

[ValeryN]

$2000 is, I believe, the IBKR min. So I used it. But is the logic right?

While can't confirm your math, stocks in general, are not a high leverage instrument because of regulations. They use to be, then Great Depression happen starting off with a biggest stock market decline in history, with leverage, at the very least, greatly contributing. While margin requirements are not the same thing, they are greatly related to that.

Eventually, margin requirement got to what it is today. With a larger account, if you are in US, you can qualify for portfolio margin which, under some circumstances gives you better leverage/margin.

Plus intraday leverage is higher, which might help in some cases.

If you don't hold overnight, I believe, there will be no interest too, at least with some brokers.

But if you want a lot of leverage/low margin, you need to use another instrument. Like currencies, futures or options. That's where you can see some crazy numbers like with 100$ you might effectively have 100k position.

Some people increase their purchasing power by cashing out their multiple credit cards. No comments on that.

Val

 

[Begbie00]

Thank you. I probably won't go the credit card route.

 

[cruisecontrol]

I'm not familiar with reg T, that is mostly for small accounts. Portfolio Margin is what someone implementing such a strategy would use.

The amount of cash you need is 15% of gross exposure. In other words 6.66:1 leverage.

e.g. $1M cash deposit => $3.33M long + 3.33M short = 6.66M gross

• you pay borrow fees on $3.33M of shorts.
• you receive interest on $3.33M of short proceeds (typically fed funds rate minus a spread charged by the broker)
• you pay margin interest on $2.33M of margin debt (3.33M long stock -1M cash) (typically fed funds rate plus a spread charged by the broker)

Lots of details will vary based on broker but that's the general idea. You most likely need an institutional level brokerage to get access to attractive spreads and full portfolio margin.

 

[Begbie00]

Thank you. So it's possible my math is off. If the Reg T 50% is also a gross exposure number, then using your math but my examples would say that I can have $2k long and $2k short = $4k gross exposure ($2k initial cash @ 2:1 leverage).