Option margin represents the cash or securities that an investor must deposit in their account as collateral before writing or selling options. These margin requirements, established by the Federal Reserve Board in Regulation T, can vary based on the type of option.
Key Takeaways
- Option margins secure positions with cash or securities required before writing or selling options.
- Requirements are based on the Federal Reserve’s Regulation T and vary depending on the option.
Basics of Option Margin
Option margin requirements are notably more complex compared to stock or futures margin requirements. Unlike these assets where margin serves as leverage to boost buying power, an option margin functions as collateral to secure a position.
Minimum margin requirements set by FINRA and options exchanges differ for various underlying securities. Brokerages can also impose their own stricter margin requirements. Some option strategies, like covered calls and covered puts, avoid any margin requirements given that the underlying stock provides the necessary collateral.
When opening a new account, traders need to request options trading authorization. Various strategies warrant different clearance levels with brokers. While buying options typically falls under Level I clearance (margin not required), selling naked puts often demands Level II clearance and a margin account. Levels III and IV could have even lower margin requirements.
Understanding option margin requirements is vital as they can significantly affect the profitability of a trade by tying up capital. Complex strategies like strangles and straddles entail multiple margin computations. Traders must ascertain these requirements before engaging in a trade to ensure market movements won’t jeopardize their capacity to meet these obligations.
How to Avoid Option Margin Requirements
Several option strategies sidestep the necessity of margin, ensuring trades go smoothly without the need for additional collateral:
- Covered Calls and Covered Puts : With covered calls and puts, owning the stock itself acts as collateral. For instance, owning 500 shares of QQQ permits the sale of five QQQ call option contracts without needing additional margin.
- Debit Spreads : These involve buying in-the-money options while selling out-of-the-money options. The advantage lies in the right to exercise the long option at a more favorable strike price, effectively offsetting the obligation to sell at the less favorable price, hence eliminating the need for a margin.
Calculating Option Margin Requirements
To simplify the calculation of option margin requirements, the Chicago Board of Options Exchange (CBOE) provides a Margin Calculator which yields precise margin requirements for specific trades. In addition, the CBOE’s Margin Manual outlines minimum requirements. Brokerage accounts may also offer tools to estimate the cost before entering a trade.
Related Terms: leverage, margin, covered calls, naked puts.
References
- National Archives, Code of Federal Regulations. “Part 220 - Credit by Brokers and Dealers (Regulation T)”.
- FINRA. “Margin Account Requirements”.
