Many traders seem overwhelmed by the prospect of figuring how much cash or buying power might be needed to support an equity or option trade.
One source of confusion is the difference between "initial margin" and "maintenance." Initial margin is what is necessary on the actual trade date. Maintenance drops way down to allow for typical market fluctuations from the day afterward until the position is finally closed out.
Example: Buy 1,000 XYZ @ $20 = $20,000 purchase
Initial margin requirement = 50% of $20,000 = $10,000
Maintenance margin = 30% of $20,000 = $6,000 (assuming the share price has not changed)
Pretty simple.
For covered calls there is no requirement other than to continue holding the matching number of shares long in the same account.
Example: If you own 500 shares of XYZ stock. you can sell up to five XYZ covered call contracts with no extra margin required at all. Any premium brought in converts that cash to double buying power.
Sell five covered calls for $1.50 per share. Collect $750. You'll then have $1,500 of new buying power. That's the same amount of buying power you would get by simply depositing $750 in new cash yourself.
Margin requirements on purchasedoptions and bull or bear spreads are very easy. It is always 100% of the full cost. Brokerage firms will not lend you any money on an asset that could expire worthless. That should reinforce the idea that owning puts and calls is risky.
Short-selling of naked options brings money in the door. But unlike what happens when you use covered calls, that cash does not convert into buying power. These transactions result in a margin requirement to assure the brokerage firm that you could make good on your pledge to buy or sell shares if the options are ultimately exercised.
You could go right to the source if you simply want to know how much is needed. You'll find this margin calculator the "tools" section on CBOE's homepage.
Just type in the strategy, premium, current quote and quantity, and send. The answer comes back instantly. CBOE's explanation seems daunting, however, and the total requirement might not jump right at you.
The illustrated example is for 10 short put contracts at a $50 strike while the underlying shares are trading at $55.
Here's a rule of thumb that works really easily while yielding close to the same final answer. Being "in the ballpark" is plenty good enough, as you never want to max out your buying power voluntarily anyway. Here is the easy method:
Multiply the net dollar commitment by 30%.
Same example: Short sale of 10 $50 puts at a premium of $2 per share
Net exercise commitment = $50 (the strike price) - $2 (the premium received) = $48 per share.
$48 x 1,000 (10 contracts) = $48,000
30% x $48,000 = $14,400
Our method avoids all that convoluted figuring.
The maintenance requirement would drop to about 20% of $48,000 = $9,600 (assuming no change in the underlying stock price).
It works the same way for naked calls.
Having a good idea of margin requirements is imperative to keep you out of the trouble. If you can't fully comprehend this simple way of calculating margin requirements, then perhaps you are not ready to be selling naked options.