I have been collecting cash flow consistently over the past several years even during the market downturn.
And yes, at times I do use margin.
But here are some important things you need to know about margin before selling options.
Initial Margin Requirement
There are two types of margin requirements we should take note of when selling options.
- Initial margin refers to the amount of margin you need to start the position.
- Maintenance margin refer to the amount of margin you need to maintain the position (so that your broker does not issue a margin call / force liquidate your positions)
Because writing uncovered or naked-options represents greater risk of loss, the margin requirements are higher. The initial and maintenance margin requirement is defined as one of the greatest of the following three formulas:
- 20% of the underlying stock less the out of the money amount (if any), plus 100% of the current market value of the option
- Puts: 10% of Exercise Value of the underlying stock PLUS the premium value
- 50 per contract plus 100 % of the premium
I will illustrate this with an actual example. I recent sold a put option on META at a strike price of 145 when the share price was 160. In return, I collected an option premium of $1.36 (i.e. $136).
I will illustrate this with an actual example. I recent sold a put option on META at a strike price of 145 when the share price was 160. In return, I collected an option premium of $1.36 (i.e. $136).
Let's go through the various formulas to first calculate our initial margin:
Example 1 - 20% Calculation
| Percentage of Stock Value: 20% x [$160 x (100)] | $3,200.00 |
| Out-of-the-Money Amount: ($145 - $160) x 100 | -$1500.00 |
| Current Value of the Option: $1.36 x 100 | $136.00 |
| Total Requirement | $1,836.00 |
Example 2 - 10% Calculation
| Percentage of Strike Value: 10% x [$145 x 100)] | $1,450.00 |
| Current Value of the Option: $1.36 x 100 | $136.00 |
| Total Requirement | $1,586.00 |
Example 3 - 10% Calculation
| $50 x 1 contract(s) | $50.00 |
| Current Value of the Option: $1.36 x 100 | $136.00 |
| Total Requirement | $186.00 |
When we take the maximum out of the three, we see the the initial margin is $1,836.00. This means that your equity should have at least this amount when you sell a put option - otherwise the broker would not let you open the position in the first place.
What Is Maintenance Margin Then?
It should be no surprise to you that share price and option value can fluctuate over time. This means that the values in the previous example.
Let's take a look at what happens if the share price increases to $169.15 and the current value of the option falls to $0.40.
Example 1 - 20% Calculation
| Percentage of Stock Value: 20% x [$169.15 x (100)] | $3,383.00 |
| Out-of-the-Money Amount: ($145 - $169.15) x 100 | -$2,415.00 |
| Current Value of the Option: $0.40 x 100 | $40.00 |
| Total Requirement | $1,008.00 |
Example 2 - 10% Calculation
| Percentage of Strike Value: 10% x [$145 x 100)] | $1,450.00 |
| Current Value of the Option: $0.40 x 100 | $40.00 |
| Total Requirement | $1,490.00 |
Example 3 - 10% Calculation
| $50 x 1 contract(s) | $50.00 |
| Current Value of the Option: $0.40 x 100 | $40.00 |
| Total Requirement | $90.00 |
The maintenance margin decreases to $1,490.00. This means that if your equity falls below $1,490.00, the broker will issue you a margin call / force liquidate your positions.
In this case, the maintenance margin decreases, which is a good thing. Many people get caught with margin call because maintenance margin increase.
Watch this tutorial video so that I can explain to you why this will happen.
If you want a copy of the google sheets, you can get it right here.
The google sheets calculator will help you calculate what is a safe amount of margin to use. If you want to know more about investing, you can check out the training webinar below.
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