Customer Portfolio Margin Disclosure

Overview of Portfolio Margining

Portfolio margining is a margin methodology that sets margin requirements for an account based on the greatest projected net loss of all positions in a class or product group as determined by an option pricing model at multiple underlying price points. A class group contains all products with the same deliverable and the deliverable itself. Within a class group, a position's profit fully offsets another position's loss at a given price point. Whereas a product group is a collection of class groups whose underlying indexes have highly correlated price movements. Within a product group, a certain percentage of a class group's net profit offsets the net loss of the other class groups at each underlying price point. A product group's offset percentage depends on the correlation of historic price movements in the underlying index of the class groups in the product group.

The goal of portfolio margining is to set levels of margin that more precisely reflect the net risk of all the positions in a customer's account. The customer benefits from portfolio margining because margin requirements calculated on net risk are generally lower than alternative position or strategy based methodologies for determining margin requirements. Lower margin requirements give the customer more leverage in an account.

Customers Eligible for Portfolio Margining

To be eligible for Portfolio Margining, customers (other than broker-dealers and certain non-broker-dealer affiliates of the carrying broker-dealer) must meet the basic standards for having an options account. In order to maintain positions in unlisted derivatives, a customer must have and maintain at all times account net equity of not less than $5 million, aggregated across all accounts under identical ownership at the clearing broker. The identical ownership requirement excludes accounts held by the same customer in different capacities (e.g., as a trustee and as an individual) and accounts where ownership is overlapping but not identical (e.g., individual accounts and joint accounts).

Positions Eligible for a Portfolio Margining Account

All positions in margin equity securities (including foreign equity securities and options on foreign equity securities provided the foreign equity is deemed to have a “ready market” under SEC Rule 15c3-1), listed options on an equity security or index of equity securities, security futures products, unlisted derivatives on an equity security or index of equity securities, warrants on an equity security or index of equity securities, broad-based index futures, and options on broad-based index futures. However, the CFTC has not yet approved the inclusion of futures products in a customer portfolio margin account.

Special Rules for Portfolio Margining Accounts

A portfolio margining account may be either a separate account or a sub-account of a customer's regular margin account. In the case of a sub-account, equity in the regular account will be available to satisfy any margin requirement in the portfolio margining sub-account without transfer to the sub-account.

A portfolio margining account or sub-account will be subject to a minimum margin requirement of $.375 multiplied by the contract multiplier for every options contract, future or warrant carried long or short in the account. No minimum margin is required in the case of equities or index unit investment trusts.

Margin calls in the portfolio margining account or sub-account, regardless of whether due to new commitments or the effect of adverse market moves on existing positions, must be met within one business day. Any shortfall in aggregate net equity across accounts must be met within three business days. Failure to meet a margin call when due will result in immediate liquidation of positions to the extent necessary to reduce the margin requirement. Failure to meet an equity call prior to the end of the third business day will result in transfer of positions out of the portfolio margining account or sub-account to the regular margin account. If the transfer of positions to the regular margin account causes the regular margin account to be under margined, a margin maintenance call will be made.

When a broker-dealer carries a regular cash account or margin account for a customer, the broker-dealer is limited by rules of the Securities and Exchange Commission and of The Options Clearing Corporation ("OCC") such that the broker-dealer may permit OCC to have a lien against long option positions in those accounts. In contrast, OCC will have a lien against all long option positions that are carried by a broker-dealer in a portfolio margining account, and this could under certain circumstances, result in greater losses to a customer having long option positions in such an account in the event of the insolvency of the customer's broker. Accordingly, to the extent that a customer does not borrow against long option positions in a portfolio margining account or have margin requirements in the account against which the long option can be credited, there is no advantage to carrying the long options in a portfolio margining account and the customer should consider carrying them in an account other than a portfolio margining account.

Special Risks of Portfolio Margining Accounts

• Portfolio margining generally permits greater leverage in an account, and greater leverage creates greater losses in the event of adverse market movements.
• Because the time limit for meeting margin calls is shorter than in a regular margin account, there is increased risk that a customer's portfolio margining account will be liquidated involuntarily, possibly causing losses to the customer.
• Because portfolio-margin requirements are determined using sophisticated mathematical calculations and theoretical values that must be calculated from market data, it may be more difficult for customers to predict the size of future margin calls in a portfolio margining account. This is particularly true in the case of customers who do not have access to specialized software necessary to make such calculations or who do not receive theoretical values calculated and distributed periodically by The Options Clearing Corporation.
• For the reasons noted above, a customer that carries long option positions in a portfolio margining account could, under certain circumstances, be less likely to recover the full value of those positions in the event of the insolvency of the carrying broker.
• Trading of securities products in a portfolio-margining account is generally subject to all the risks of trading those same products in a regular securities margin account. Customers should be thoroughly familiar with the risk disclosure materials applicable to those products, including the booklet entitled Characteristics and Risks of Standardized Options.
• Customers should consult with their tax advisers to be certain that they are familiar with the tax treatment of transactions in securities products.