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Risk Control Requests (& other Account Settings)
2X and 3X ETF Equity and Margin Risk Control
Last Activity 5/17/2016 11:06 AM
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John W

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Subject : 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 12:41 AM
Post #35727

Recently OV traded a couple of 2X and 3X ETF's and I suddenly had a margin call on my account.
I didn't realise that the margin on 2X and 3X ETF's is also 2X and 3X!

I was able to adjust for this by reducing the trade size to a half (for 2X ETF's or a third (for 3X ETF's).

Then I couldn't get around one other issue.
Even though I had established control of the individual margin risk I found that that OV still pushed my trades over the broker account 100% limit because it valued the 2X and 3X ETF's as 1X only.

A simple example - imagine you have 5 1X positions at 20% each. Broker Total 100%.

Now assume instead there are 2 2X ETF's and 3 1X ETF's. Broker Total 140%.

Then using my simple solution the 2X ETF's are forced to half size in OV(10%), therefore they now use 20% broker equity each instead of 40%. The broker sees this as 20+20+20+20+20=100%. So the broker problem appears to be solved.

BUT OV looks at this and assumes the 2X ETF's now only use 10% equity. OV sees 5 positions totalling 10+10+20+20+20=80%. OV then tries to fill the remaining 20% account value with another ETF to get to it's 100% account allocation.

But that extra ETF takes the broker account from 100% to either 120%, 120% or 120% depending on whether the extra ETF selected was 1X 20%, 2X 10% or 3X 6.67%

Anyway, that was my problem, I've managed this by hands on manual calculations and account adjustments to compensate.

It would be really good if this aspect could be handled in OV!

It may need some intelligence in the symbol list for OV to know the difference between a 2X or 3X ETF.

[Edited by John W on 3/24/2016 1:12 AM]

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Steve Luerman

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 5:10 PM
Post #35739 - In reply to #35727

John,
I've got an IRA account in which some leveraged ETFs have been traded by OV. Obviously, the IRA is not a margin account, and there has not been any problem. So, I gather that what you are describing is strictly the effect of leveraged ETFs on a broker's margin calculation. I'll watch for that in the future on my margin account.

Given what you have described, the only automated solution is for OV to account for the margin calculation as you've requested.
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BrianD

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 5:58 PM
Post #35740 - In reply to #35727

John: Never knew 2x/3x was looked at as a margin position - makes sense though. Thanks for the heads up.

So, trying for a teaching moment on your experience.

I'm assuming you are now throttling back the 2x - 3x allocations at the strategy level (when using a single Strategy/symbol process).

If so, is the "Allow settings to reduce trade size" OV Account setting or TP setting "Size by % of Equity" over-ruling your Strategy settings? Seems something is trying to use up what it perceives as available cash?

Lots of knobs (and broker rules) here...
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John W

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 6:28 PM
Post #35741 - In reply to #35739

Steve, I don't have an IRA (not a US citizen) so yes, my experience is based on a margin account.

However if OV doesn't distinguish a 20% position in a 1X ETF (20% of IRA tied up at broker) from a 20% position in a 3X ETF (60% of the IRA tied up at broker), then it seems to me there is potential for the IRA broker to stop the 3X trade if it would take the account over the 100% allowed.

Perhaps you haven't hit the right combo of ETF's to take you over the broker limit yet, or my thinking is skewed because I don't have a proper understanding of IRA's?
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Steve Luerman

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 6:43 PM
Post #35742 - In reply to #35741

John,
My understanding and experience with 2x and 3x ETFs are that they are simply handled as a 1x ETF. That is, there is no "scaling" done by the broker. When I purchase 100 shares at $50/sh, I get 100 shares for a total transaction amount of $5000+commission. There is no margin consideration in an IRA. The 2x/3x ETF will go up and down faster than the 1x ETF, but that's not the broker's concern, since they don't have any risk in this non-margin transaction.

And I have to say, that has been my assumption as well in my margin account. But I have not looked for this, so I can't say for sure that it didn't happen. I'll be on the lookout for it next time I enter a 2x/3x ETF trade in my margin account.
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John W

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 6:52 PM
Post #35743 - In reply to #35740

Brian, Yes I did throttle back. However I throttled back at the portfolio level because the portfolio had all strategies set to 20%.

Theoretically you can throttle back at the strategy level using the Allocation %, or at the Portfolio level using the trade Multiplier % ASSUMING all strategies in the portfolio are at the SAME % per trade.

In the example I gave earlier there was no "Allow Settings to Reduce Trade Size" because OV was set to trade 20% of equity per trade, and since OV thought it had only used 80% equity, it made room for one more trade of 20%.
So OV was doing what I had instructed, to use the available cash up to 100%, either in 5 trades of 20%, or 5 trades of (10+10+20+20+20) + a sixth trade of 20%=100%.

Unfortunately at the broker this sixth trade takes the account to 120%, so if it's a 2X margin account it takes the account to 240% and a margin call will result at end of day!

[Edited by John W on 3/24/2016 7:05 PM]

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John W

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/24/2016 7:02 PM
Post #35745 - In reply to #35742

Steve, Yes, that seems right, but again IRA's are not my expertise...
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Mark Holstius

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/25/2016 4:55 PM
Post #35746 - In reply to #35745

Hi all...

I just thought I'd throw in the applicable paragraph from the Finra reg on Maintenance Margin for ETFs that changed in 2009 (reg attached), along with a simple chart I made to help visualize the rules. It gets really complex when you have various differently leveraged ETFs in a margin account, but maybe this will help someone visualize the simple case...??? Do you have something different "down under", John?

Mark

Strategy-Based Margin Account
In general, FINRA is increasing the maintenance margin requirements for leveraged
ETFs and associated uncovered options by a factor commensurate with their leverage.
In a strategy-based margin account, the current maintenance margin requirement for
any long ETF is 25% of the market value, and for any short ETF, the current maintenance
margin requirement is generally 30% of the market value.3 Effective December 1, 2009,
these maintenance margin requirements will increase by a percentage commensurate
with the leverage of the ETF, not to exceed 100% of the value of the ETF, as detailed in
the following examples:

Long 100 shares ABC ETF@28.00 (200% leverage)
Market Value: 2,800
Maintenance Requirement: 2 x .25 = .50
2,800 x .50 = 1,400
Short 100 shares DEF ETF@26.00 (300% leverage)
Market Value: 2,600
Maintenance Requirement: 3 x .30 = .90
2,600 x .90 = 2,3404



[Edited by Mark Holstius on 3/25/2016 4:59 PM]

Attached file : Maintenance Margin.jpg (117KB - 546 downloads)
Attached file : Finra Reg 09-53.pdf (82KB - 106 downloads)

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Jim Dean

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/25/2016 5:36 PM
Post #35748 - In reply to #35746

The graphs tell the story clearly.

This absolutely has to be handled by internal calcs in OVest ... Barry, could you please acknowledge that it's been put on the list?

This is really important also for OmniFunds, so hopefully it will be given a high priority.

Thanks
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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/25/2016 8:05 PM
Post #35751 - In reply to #35748

Here's another way to look at it with a chart...

Assume you have a $100,000 Account and use 2X Margin.
Your Maint Margin top limit is $100,000 (max equity available)
What is the maximum amount you can invest in an ETF given the Maint Margin requirements for various leverages and Long / Short?

Mark




[Edited by Mark Holstius on 3/25/2016 8:09 PM]

Attached file : Max Dollar ETF.jpg (445KB - 477 downloads)

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Mark Holstius

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/26/2016 2:54 PM
Post #35753 - In reply to #35727

John,

After some more thought using what I found in my posts above, I think I may have a way to let OV adjust the leveraged ETFs so that the margin calls might be eliminated. It would require putting the leveraged ETFs into their own Portfolios and adjusting their Max % Invested. Rather than go into a long explanation, I put together a spreadsheet that I hope explains the idea step by step. I've included a snag of the spreadsheet and attached the spreadsheet. See what you think...




I don't have time at the moment to test it in an OV simulation to see if the resulting trades would stay under the limit, but I'll try to get to that sometime soon.

Mark

[Edited by Mark Holstius on 3/26/2016 3:01 PM]

Attached file : Margin Call Solution.xlsx (93KB - 85 downloads)
Attached file : Margin Call Solution2.jpg (359KB - 446 downloads)

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John W

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/27/2016 4:03 AM
Post #35754 - In reply to #35753

Mark, I like your spreadsheet, thanks for taking the time to consider this, it’s a good template.
Also thanks for finding the correct details from FINRA.

The Portfolio Max you suggest would be fine if each portfolio was traded in a separate Account.

Using your figures the 2X portfolio at its max limit in a margined Account would eat up 192% of the available 200%, 3X in another separate Account eats up 128% etc. (first group in table below).
So if each portfolio was traded in a separate Account there would be no risk of exceeding margin in each of those Accounts.

Trading as Portfolios in a single margined Account, 2X eats up 190%, 3X a further 83%, -2X 130% and -3X 58%, Total 461% - well over the 200% Account limit (second group in table below).

It’s possible to prorate the account equity back to using 95% before margin and then with the various factors on each Portfolio the single Account would run at 152% with margin (third group in table below).

There are issues with each of these approaches.

Setting up 4 Accounts to deal with the issue is clumsy and a waste of scarce OV Account resources and scarce cash resources.
If (say) -3X is rarely used then one quarter of available equity sits idle.

Trading in a single margined account with caps on each Portfolio % has the same issue - available equity sits idle in underutilised Portfolios and Portfolios that want the equity can't access it.
Total account equity maxes out at 152% in my prorated example. This can be varied if some Portfolios don’t trade much or at all so that larger caps can be placed on frequently used Portfolios.
Once setup the caps can be left alone but still at the risk of underutilisation. If the percentages are changed regularly to use the underutilised account equity and margin then manual intervention daily is required to ensure trades are not placed that put margin limits at risk.

Neither multiple Accounts nor a single Account with set Max Invested % limits is flexible enough to cope with underutilisation of equity and margin, and manual intervention daily is a chore and prone to errors.

I believe the right answer is for Nirvana to upgrade Omnivest to carry the margin percent of each ETF and utilise that information to place the correct trade size.





[Edited by John W on 3/27/2016 4:10 AM]

Attached file : ETFSizing.png (34KB - 430 downloads)
Attached file : ETFSizing.xls (36KB - 70 downloads)

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Jim Dean

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/27/2016 5:49 AM
Post #35755 - In reply to #35754

"believe the right answer is for Nirvana to upgrade Omnivest to carry the margin percent of each ETF and utilise that information to place the correct trade size"

Yes. This is Nirvana's job, not ours. The OV user interface is not amenable to working around the native differences in how the broker handles one security vs another. This issue must be addressed internally.
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Mark Holstius

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/28/2016 7:25 PM
Post #35760 - In reply to #35754

I’ll take a stab at simplifying things a bit… but there's probably a good chance I'll just “muck it up”.

While it would be nice to have Nirvana tag each ETF with its leverage and do the math for various specific brokers, I don’t expect them to devote the resources to accomplish that – so I’m looking for a reasonable alternative to use in the meantime to minimize the chance of margin calls using leveraged ETFs.

My proposal has been to put the leveraged ETFs into separate Portfolios (+/-2X, +/-3X) with unique Max % Inv restrictions for each, but keep them in the same Account. (see previous posts about req’d Maint Margin & specific values)

By separating out the leveraged ETFs into Portfolios nested in an Account with the necessary restrictions on each, the Account will always have access to all the equity for trading, but never more than that (i.e. you can’t “over boost” it by changing the Max % Inv in it’s Portfolios). So, I don’t feel it’s necessary to put these leveraged portfolios into their own accounts.

The -3X 90% overnight margin requirement means that you’re limited to having $111,111 in 3X positions in a $100,000 2X margin account to still meet the margin requirements. If your -3X positions totaled $150,000, you’d need $135,000 of equity. Likewise, if your original trade was OK the 1st day but your account equity goes down, you could still get a margin call.

To demonstrate how the Max % restriction works, I’ll run OV with some sample portfolios I built that show the results for the 2 months from 2/1/16 – present:

In the example below I’ve only used -3X ETFs in the portfolio.
There are 2 tables showing the trades starting 2/1/16.
The left table shows all the trades with the Portfolio Max % Invested set at 100%.
The right table shows all the trades with the Portfolio Max % Invested set at 51% (with all trades similar to the left aligned).
I’ve highlighted 3 groups of trade days where there was a large amount of equity in -3X ETFs on the same day (2/3/16=yellow, 2/18/16=orange, and 3/3/16=green which has some overlap with orange).

Notice that on the left side we’d have far too much allotted in -3X ETFs to still meet the 90% margin requirement, but by setting Max % Inv at 51% on the right side, OV limits the trades to a sum of ~100% of equity, leaving us with the required 90% margin:





A similar example using +3X (requiring 75% Maint Margin) yielded one day that was brought back to the necessary level when using a 62% Max % Invested limit (2/18/16):





Interestingly, if I put them together and add in a -2X portfolio set at 78% Max % Invested there are enough trades of various forms that the restrictions only have an effect on the number of -3X trades on 2/2/16:






In summary, these restrictions only come into effect on days when you have a large number of trades of the particular type (+/-3X, etc.) along with enough free equity to fund the trades – i.e. having 50%+ of your equity in leveraged ETFs. But even though they may not happen often, they can give you overly optimistic results in an OV backtest - so unrestricted backtests with leveraged ETFs could be suspect.

It’s been interesting investigating this, and I’d like to share a few thoughts;

Leveraged ETFs are great for day trading, and I have friends who’ve done well trading 2 & 3X ETFs in OV - but we need to be aware that there’s potential for problems if held overnight with their Maintenance Margin and daily “reset”. (See attached SEC article)

Also, if there’s a large move in the markets and we’re on the wrong side we can get burned quickly. (duh?) Given today’s environment (think flash crash, terrorist attack on the financial markets, etc.) it might it be prudent to use leverage more often to the short / inverse side than long. I don’t remember many “flash up” moves…

Last, I plan to consider manually setting a wide stop in case I'm unable to monitor the trade due to an outage or something. (Yes, my AWS account went down and I got no notice because the Trade Processor and its ability to notify me went down with it)

I’m not an expert – just observing….

BTW, the Elite Trader Portfolio I published is < 1/3 leveraged (only at 2X) - and those ETFs are weighted to the inverse side:
95 1X vs 44 2X
5 +2X vs 39 -2X

Sorry if I rambled too long - best of luck in your trading,
Mark


[Edited by Mark Holstius on 3/28/2016 7:32 PM]

Attached file : -3X trades.jpg (1323KB - 387 downloads)
Attached file : +3X trades.jpg (1046KB - 390 downloads)
Attached file : +3X -3X -2X trades.jpg (2080KB - 384 downloads)
Attached file : SEC Article On Leveraged ETFs.pdf (163KB - 90 downloads)

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Steve Luerman

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/28/2016 7:54 PM
Post #35761 - In reply to #35760

Mark,

First - a question - you implied this is a broker specific thing. Is that true? I thought you posted a regulation which spelled out how this works.

Assuming all brokers have to meet the regulation:

I have not yet evaluated your proposal. But, Ed hopes/intends for OV to be a portal used by a significant population looking for a relatively easy investing/trading tool to manage their funds. Nirvana and Elite Traders will be posting portfolios which use +/- 2x and 3x ETFs (and have already done so) for use by this diverse population. If they (the diverse population) have negative experiences, they will not stick around. I think Ed's team will need to address this eventually in such a way that it is handled "under the covers" rather than each portfolio developer worrying about whether they and their portfolio users have handled it correctly. And it needs different handling based on whether it is a margin account or an IRA account.

Your proposal may provide a work-around for the moment, but long-term I believe it needs to be factored into the OmniVest mechanism, and well documented for everyone to have confidence it is handled correctly, and not result in surprises.
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Mark Holstius

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/28/2016 8:02 PM
Post #35762 - In reply to #35761

I totally agree Steve... to make it easy, Nirvana needs to address the problem. I just want to point out that not adjusting for it could lead to unrealistic backtests now - and this seems to be a possible work around until they do.(?)

The only reason I mentioned that it may be broker specific is for those trading overseas. I can't be sure of their rules.

For the US brokers used by OV at the moment, AFAIK those FINRA rules apply.

BTW - if Nirvana does make changes, I suspect it would be EXTREMELY difficult to cross-check their work & the results on an historical basis in an account...??? (What happens as far as a margin call after the trade is open & the equity goes down during a DD? - it can be more complicated than at first glance)

Mark

[Edited by Mark Holstius on 3/28/2016 8:10 PM]

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Steve Luerman

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 3/28/2016 8:21 PM
Post #35763 - In reply to #35762

Good point - extreme drawdowns of an account's total value would result in margin calls which I would NOT expect to be modeled or accounted for in historical backtesting.

Perhaps some overseas traders will comment on whether they know what rules apply to their accounts.

Mark - thanks for the research and suggestions you've provided. It is appreciated.

Steve
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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 5/7/2016 4:02 PM
Post #35861 - In reply to #35763

I believe that Jim is correct. This needs to be solved by OV and Omnifunds. Hopefully, Nirvana's data provider will enable them to electronically determine ETF leverage as there are new ETFs popping up every day. For US brokers/clearing houses, the margin rules are the same but the time of day they are enforced can vary from clearing house to clearing house. This has implications for when concurrent buy and sell orders can be submitted if an account is trading near margin limits. Omnifunds will need to implement a solution to this that works across all integrated brokers/clearing houses. Hope both of these things are on the Omnifunds to-do list.
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BrianD

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 5/7/2016 5:38 PM
Post #35863 - In reply to #35760

Mark: Saw you note about AWS outage. Been using cloud processors from IBM and Amazon for quite a few years and never had outage on their cloud compute platforms without warning from vendor (but then, never say never).

However, have had MS server reboot due to an automatic software update, which of course shuts down TP, etc. For anyone planning to use cloud computing, DO NOT ALLOW AUTOMATIC UPDATES.

Learned that the hard way.
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Wes Smith

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 5/17/2016 9:18 AM
Post #35904 - In reply to #35751

The original purpose of 2x/3x was to increase leverage.
Seems like the 2009 rules remove that advantage.
I remember reading about this rule. It was supposed to help settle down the big market moves that were blamed on large players tripling their influence (my oversimplified view)

I did some tests on my IB account and it doesn't look like IB enforces these margin rules.

For example.. I made an order for SSO 100 shares at a $20 limit.
Then I use the IB Check Margin tool for the order and it showed it as $2000. Didn't reflect the margin.

So it looks like I could buy $100K of SSO in an $100K account?

Or do the margin call rules come into affect at EOD or other reconciliation time?

I will ask IB and report back here.
Wes
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Wes Smith

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Subject : RE: 2X and 3X ETF Equity and Margin Risk Control
Posted : 5/17/2016 11:06 AM
Post #35906 - In reply to #35904

Answer back from IB

The rules we are discussing only apply to Margin accounts.
To prevent a pattern day trading acct with 4x Margin from effectively becoming a 12x Margin account when trading 3x ETF.

CASH accounts can fully use these leveraged products up to the cash balance of the account.

So no effect on Cash but lots of effect on Margin, depending if the account has triggered the pattern day trade rule.

I think it makes quite a mess for OV to eventually automate.
OV will need account settings for margin/cash as well as pattern-day-trader status.

Pattern day trader status would be a reasonable thing for OV considering how frequent some of these strategies trade, and would be almost automatic once R/T trading is enabled. Triggered when you make more than 4 in/out day trades in a week. Google for more precise info.

Wes
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