What is Option Margin
Let me explain what option margin is: it's the cash or securities you, as an investor, must deposit in your account as collateral before you write or sell options. These margin requirements come from the Federal Reserve Board under Regulation T, and they change depending on the type of option you're dealing with.
Key Takeaways
- Options margins are the cash or security that traders must submit to the broker as collateral before writing or selling options.
- Option margins are typically based on the Federal Reserve's Regulation T and vary based on option.
Basics of Option Margin
You need to grasp that option margin requirements are complex and quite different from those for stocks or futures. With stocks and futures, margin serves as leverage to boost your buying power, but for options, it's strictly collateral to secure your position.
FINRA and the options exchanges set the minimum margin requirements for various underlying securities, and remember, your broker might impose even stricter ones by adding to those minimums. Strategies like covered calls and covered puts skip the margin requirement entirely because you use the underlying stock as collateral.
When you open a new account, you have to request authorization for options trading. Brokers often categorize this into clearance levels based on the strategies you plan to use. Buying options usually falls under Level I, which doesn't need margin, but selling naked puts might require Level II and a margin account. If you get to Level III or IV, you often face lower margin requirements.
Keep in mind that option margins can seriously affect your trade's profitability by tying up your capital. For complex setups like strangles or straddles, you might need to calculate multiple margin requirements. Always figure out the margins for a trade beforehand and ensure you can cover them if the market moves against you.
How to Avoid Option Margin Requirements
Certain option positions don't require margins at all. For instance, long options—whether puts or calls—have no margin needs. You can also employ strategies to sidestep these requirements altogether.
Take covered calls and covered puts: these involve owning the underlying stock, which serves as your collateral. If you own 500 shares of QQQ, you can sell to open five contracts of QQQ call options without putting up any margin.
Another approach is debit spreads, where you buy in-the-money options and sell out-of-the-money ones. Here, the right to exercise the long option at a better strike price cancels out the obligation to sell at the worse one, so no margin is required.
Calculating Option Margin Requirements
The simplest way to calculate your option margin requirements is by using the Chicago Board of Options Exchange (CBOE) Margin Calculator, which gives you exact figures for specific trades. You can also check the minimums in the CBOE's Margin Manual. Your brokerage account might offer similar tools to estimate costs before you enter a trade.
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