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"How To Erase Margin Requirement In a Time Spread?"

Question By Antonio Guzman

"How To Erase Margin Requirement In a Time Spread?"

When you buy a LEAPS Call and write a near term call option against it then you erase the margin requirement. With that said, how far out in time should the long call be and how can the margin requirement be eliminated if you don't own the stock?

Asked on 24 Oct 2009

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Answered by Mr. OppiE

Hi Antonio,

First of all, when it comes to options margin, not every broker handles it the same way. Therefore, for more specific advise, you need to refer to your specific options trading broker and their margin policies.

In options trading, almost every broker requires no margin for debit spreads. Debit spreads are options trading strategies which you pay money to put on. The time spread in your question is mostly likely a debit spread if the near term call options have an equal or higher strike price than the long term call options. In this case, no margin is required as long as the expiration date of the long term call options is equal or longer than the short term options. Why is this so? Even though you do not own the stock, you own the RIGHT to buy the stock at a price equal to or lower than the short term call options that you sold. This guarantees that you would be able to fulfill your obligations of selling the stock at the short term call options' strike price should those options get exercised.

Assuming AAPL is $200 and you decide to put on a horizontal time spread on it by buying its April 2010 $200 strike price call options for $18.00 and writing its November 2009 $200 strike price call options for $5.00. The position costs you $18 - $5 = $13 to put on, hence it is a debit spread requiring no margin. Even if the short term $200 strike price call options are exercised, you still own the right to buy AAPL at $200, see? That is why no margin is required.

Now, the complex part about margins for time spreads comes when a time spread is put on as a credit spread. A credit spread is a position where you actually receive money for putting it on. A time spread becomes a credit spread when a call option of lower strike price is written against a call option of a higher strike price (credit diagonal time spread) or when short term options are BOUGHT and long term options SHORTED at the same strike price (short horizontal time spread).

When a time spread is put on as a credit diagonal time spread, almost all brokers will require margin as you have the rights to purchase the underlying stock for a higher price than the obligation to sell those stocks. This creates a shortfall when the position is liquidated, hence the margin requirement.

Assuming AAPL is $200 and you decide to put on a credit diagonal time spread by buying its April 2010 $200 strike price call options for $18.00 and writing its November 2009 $150 strike price call options for $54.00. This position puts $54 - $18 = $36 into your pocket when it is put on, hence it is a credit spread requiring margin. If the short $150 strike price call options are exercised, you would have to deliver AAPL stocks at $150 but you only have the right to buy AAPL stocks at $200. This creates a shortfall of $50 which you would have to cover which is where margin comes in to make sure you have that money ready if the position is liquidated this way. Of course, every options trading broker would have their own policies on how much margin is required for a time spread like this.

When a time spread is put on as a short horizontal time spread, theoretically no margin should be required as the position is fully covered. However, there are options trading brokers who will then take both legs of that trade as individual trades and charge a margin on the short leg as an individual naked write position. You will need to find out how your broker deal with such situations.

In conclusion, in order for a time spread to require no margin, it doesn't matter how far an expiration your long term call are as long as it is equal to or farther in expiration than the short term call options and that the short call options have an equal or higher strike price than your long term options. The rights that you own in the long term positions are a good offset against the short options even if you do not own the underlying stock as long as that right allows you to equal or better the obligations that you have in delivering the stocks under the short call options written.

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