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The average investor has no interest in putting on large leveraged positions. For most this type of trading was too stressful and overwhelming. The only avenue for retail investors to raise the risk level of their investment activity was investing in futures and options trading directly or through an investment in a managed futures fund. But even these ventures were too risky for most.

FIGURE 7.9 Monthly Chart MCSI Emerging Markets ETF Source: Chart Courtesy of

Enter the SEC, which changed the rules in April 2007 to accommodate risk takers. As we mentioned in Chapter 4, the embedded market bullish bias got a further lift when the SEC altered margin rate calculations and rules making it easier for individuals to increase risk through added leverage. The key change was to allow brokers and investors to engage in "portfolio margin'' calculations versus previous "position margin'' rules.

The basic impact of the rule change was to lower margin deposits from 50 percent for each position to 15 percent based on what regulators

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and brokers deemed overall portfolio risk. Further the SEC had restricted this activity to accounts with assets exceeding $5 million. This eliminated most retail clients from participating. But the SEC decided to drop this restriction allowing its application to any investor. Some people think this is like eliminating the age limit for casino gambling. Is this too paternalistic a view? Time will tell.

The biggest initial impact is to investors incorporating options transactions to their investing strategies. Let's say you wish to buy 1,000 shares of

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FIGURE 7.11 Monthly Chart Spain ETF Source: Chart Courtesy of

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FIGURE 7.11 Monthly Chart Spain ETF Source: Chart Courtesy of

XYZ stock for $100 and at the same time buy puts against the position. Old margin would require a $50,000 deposit on XYZ and the full amount on the option, which, if the option was $1,000 you would need to deposit the full amount or $51,000. The new rules could reduce the deposit to only a little more than $4,000. This is a dramatic change.

From an article posted April 5, 2007 at by Steven Smith:

Some of the key features of the new amended plan proposed by the Chicago Board of Options Exchange and the NYSE that were

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approved by the Securities Exchange Commission last December, but went into effect on April 2 include:

■ Removing the $5 million account minimum, but most brokers still can impose their own minimum account balances and trading experience thresholds.

■ Portfolio margining will be expanded to include all equities and their related options, not just index products. It also

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will allow some cross margining of "highly correlated products." For example, options on the S&P 500 Index can be offset with options on the SPDR Trust (SPY). It will also include some similar futures contracts, and there will no longer be a need to have a separate cross-margining account. (

Smith went on to say that not all firms would implement these rules, since to do so requires a complete overhaul of their internal margin rules and monitoring. As he says, "It will be a headache'' to implement and manage.

FIGURE 7.14 Monthly Chart Australia ETF Source: Chart Courtesy of

However, competitive pressure will force many firms to participate since it's anticipated that trading volumes will increase and firms won't want to lose customers by not offering their own models.

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