Question By Antonio Guzman
"When Is There Margin Requirement in Options Trading?"
When is there a margin requirement? does it matter whether it's a credit or debit spread? or what about if the long to short ratio is 1:2 so you have more shorts than longs?
Asked on 9 Sep 2009
Answered by Mr. OppiE
To put it very simply, whenever you have positions with risk potential greater than what you paid to put the position on, margin would be required. This is due to the broker's need to make sure that you are able to close the position when you have to.
The simplest way to understand this in options trading is when you write naked (uncovered) options. When you write an option, you are exposed to unlimited risk in exchange for limited profit. For instance, if you write a $10 strike price call option for $1.00, you gain $100 if the underlying stock ends at or below $10 upon expiration of those call options but if the stock rises above $10, say to $20, the holder of the option can exercise the option to buy those stocks from you for that same $10. You would then have to buy the stocks from the market for $20 and then sell it to the holder of the options at $10, incurring a total loss of $1000. In this case, the broker would make sure you have a significant amount of cash in your account BEFORE allowing you to write those call options so that in the case of an exercise, as outlined in the example above, you have the cash to buy the stocks from the market. This cash is known as the margin. Options margin is very different from margin in stocks as you can read from our Options Margin tutorial.
Similarly, when you write naked put options, you will be under the obligation of buying the stocks from the holder of those put options at the strike price anytime the options are exercised. Your broker would hence require you to have that cash in your account before allowing you to perform that options strategy. This cash is options Margin.
Yes, margin is pretty straight forward to understand in the case of naked options positions. However, margin becomes complex to calculate or understand when options strategies are involved. In options trading, both long and short options can be put together to form complex positions with complex net effects that justifies different amounts of margin. In fact, different brokers may have very different ways of calculating margin requirement for complex options trading strategies such as the Butterfly Spread. In general, all credit spreads require margin as all of them have higher risk potential than what you paid for (which is $0). However, debit spreads are a bit more complex. Some debit spreads requires margin and some don't. Some requires a negligible amount of margin when traded with one options trading broker but the same strategy may require an extremely high margin when traded with some other brokers. In general, as long as the risk potential of the debit spread is higher than what you paid to put the position on, you can be sure there is margin involved.
In the case of your 1:2 ratio spread mentioned in the question, only one short
leg is covered while the other short leg remains open even if the overall position is a debit spread, as such, margin will be required.
In conclusion, the principle behind options margin is that of making sure the writer is capable of closing the position without default in order to low the risk faced by the broker itself. Different brokers have different practises especially when it comes to complex options trading strategies. There is a set of guidelines regarding options margin issued by the CBOE but not all brokers follow those guidelines. It is best to study the margin requirement schedule of the options trading broker that you currently use for more precise answers.
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