What is options margin? How does options margin work? Why do I need margin in options trading?
Options Margin - Introduction
Margin has always been a topic stock, futures and options traders have struggled with. The problem with understanding margin is that margin means a
different thing for all 3 financial instruments!
That is why stock traders or futures traders usually confuse themselves on what margin means in
options trading. Although confusing, understanding what options margin is and how it differs from stock and futures margin is essential for an
options trader's complete understanding in executing options strategies, particularly options credit spreads.
This tutorial shall explain what
options margin is and the differences between options margin and stock / futures margin
Options Margin - Content
What is Options Margin
How is Options Margin Determined
Exemption from Options Margin
Difference Between Options and Stock Margin
Difference Between Options and Futures Margin
What is Options Margin?
Margin in equity and index options trading is the amount of cash deposit
needed in an options trading broker account when writing options
. Writing options
means "Shorting" options and happens when
Sell To Open
orders are used on call or put options. Options margin is
required as collateral to ensure the options writer's ability to fulfill the obligations under the options contracts
When you write (short by using Sell To Open orders)
, you are obligated to sell the underlying stock to the holder of those call options
if the options are
. If you don't already have those stocks in your account, you will have to buy those stocks from the open market
in order to sell to the holder of those call options. In order to ensure that you have the money to buy those stocks from the open market when the
options trading broker
will require you to have a certain amount of money in your account as deposit and that's options
margin. This is what happens in a
Naked Call Write
options trading strategy.
Similarly, when you write put options, you obligated under the
contracts to buy the underlying stock from the holder of those put options
if the options are exercised. That is why the options trading broker needs to make sure that you have sufficient money to buy those stocks from the
holder of the put options when assigned, hence the need for options margin. This is what happens in a
Naked Put Write
options trading strategy.
Writers of options are also exposed to unlimited risk and limited profit, which means that the position can lose more and more money the more
the underlying stock goes against your expectation. In order to close such losing positions, you would need to
Buy To Close
that is why options trading brokers also need to make sure you have enough cash in your account to be able to do that.
This is why a lot of beginner options traders would have experienced their brokers returning an error message such as "You need at least
$100,000 in your account in order to write uncovered call/put." when attempting to write
Please note that options margin in this case do not apply to Futures Options or Options on Futures, which has a more sophisticated treatment..
How is Options Margin determined?
Options margin requirement is really the options trading broker's way of lowering the risk they face when allowing their account holders to
write options. As the OCC ensures the fulfillment of all options contracts exercised, the responsibility falls on the broker should their account
holder be unable to fulfill. This is why all options brokers would have their own way of determining how much options margin is needed for
every scenario. The CBOE, Chicago Board of Exchange, also has a set of margin suggestions for all member firms which can be downloaded in pdf
CBOE's Margin Manual
site. However, you should understand the
specific margin requirement of your options trading broker as it can be very different from what is suggested by CBOE. Some brokers have
slightly more relaxed requirements while some other brokers have slightly stricter ones.
No matter how much margin is required by each broker, margin requirements for stock and index options are always fixed percentage amounts to be applied
uniformly in each scenario. This is unlike the variable margin requirement for futures options or options on futures.
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Exemption from Options Margin Requirements
There is one scenario which options can be written without margin requirement and that is when there is an alternative collateral in the form
of owning a position in the underlying stock or a more in the money long option of the same kind than the one being sold (an options spread).
Owning a Position in the Underlying Stock
Owning a long position
in the underlying stock allows you to freely write as many call options at any strike price without involving options margin.
This is because the long stock position is a good collateral which can be sold to the holder of the call options at the strike price when the
call options are exercised. That is why there are no margin requirements for the
options trading strategy.
Example : Assuming you own 700 shares of QQQQ at $44. You can Sell To Open 7 contracts of QQQQ call options without any margin.
Owning short position
in the underlying stock allows you to freely write as many put options at any strike price without involving options
margin as well. Even though margin is not required for writing the put options, margin is necessary for the shorting of the stocks in the first
place, which is a different requirement from options margin. This is because the money needed for the buying back of those short stocks would
already have been taken into consideration when shorting the stocks, which made sure that the money needed for buying the stocks from the
put options holder is available if exercised. That is why there are no margin requirements for the
options trading strategy.
Example : Assuming you shorted 700 shares of QQQQ at $44. You can Sell To Open 7 contracts of QQQQ put options without any margin.
Margin Requirements for Options Spreads
There are no margin requirements when putting on debit spreads
are spreads where you actually pay money to own. Debit spreads usually
involve buying a certain amount of an option and then sell to open further
out of the money options
of the same kind. In this case, the right to
exercise the long option at a more favorable strike price offsets the risk of fulfilling the obligations on a less favorable strike price, erasing
the need for options margin. This is what happens in options strategies such as the
Bull Call Spread
Example : Assuming you own 7 contracts of QQQQ's Jan45Call. You can sell to open up to 7 contracts of QQQQ's Jan47Call (or any higher strike
price) without any margin.
are used, options margin will be required.
This is because credit spreads are options positions that consists of shorting more out of the money options than there are
in the money options
to be secured against or shorting of in the money options while buying out of the money options. In both cases, the long leg in the position
helps to reduce the margin requirement of the overall position, making it easier to execute than outright (naked) short call or put options.
In this case,
brokers usually requires 100% of the difference in strike prices multipled by the number of contracts as options
Difference Between Options Margin and Stock Margin
What confused most stock traders turned options traders is the difference between stock margin and options margin. Stock margin is the ability to
buy more stocks than your money allows you to by borrowing from the broker. This is totally different from margin being cash collateral held in the
account for the purpose of writing options. In fact, a lot of beginners ask questions like whether options can be bought on margin like stocks.
The answer is a resounding NO. Options margin applies only when shorting / writing options. There are no margin involved in buying options at all
and there are currently no borrowing facilities for options.
Also read the Differences Between Stocks and Stock Options
Difference Between Options Margin and Futures Margin
Margin in futures is also totally different from margin in options. Margin in futures trading
is similar to margin in options writing in the sense
that they are both money that are to be held in the trading account in order to fulfill the obligations under the contracts when things go wrong
for the trader. What is different is the fact that there are 2 kinds of margins in futures trading; Initial Margin and Maintenance Margin. Losses
resulting from the position are automatically deducted from the initial margin by the end of each trading day and then a top up would be needed
as determined by the maintenance margin when the initial margin runs low. This is totally different from options margin as no deductions from the
cash held is made at the end of each day even if the position is in a loss.
Also read the Differences Between Futures and Stock Options
What About SPAN Margin?
SPAN Margin is short for Standardized Portfolio Analysis of Risk margin. This is a margin system for options on futures, which is based on the
same need to reduce risk of assignment but not using a fixed percentage for each scenario but based on an extremely sophisticated algorithm which
determines the worst case one day risk of an account. This system better ensures performance of contracts and reduces margin requirements for
lower risk positions. SPAN margin is currently available for options on futures only and not for equities and index options (true as of Jan 2009).
Questions Regarding Options Margin
"When Is There Margin Requirement in Options Trading?"
"SPAN Margin For Spreads?"
"How To Erase Margin Requirement In a Time Spread?"