What is option margin
Option margin is the cash or securities an investor must deposit with their broker as collateral when writing (selling) option contracts. The margin requirement exists to protect the broker (and the clearinghouse) from the risk that the option writer will be unable to meet obligations if the market moves against the position. Margin rules for options are set by regulators and exchanges (with brokers able to add stricter requirements), and they differ from the margin rules for stocks or futures because option margin is primarily collateral against obligation rather than leverage to increase buying power.
Key takeaways
– Option margin is collateral required when you write (sell) options; long options do not require margin.
– Margin rules are established by Regulation T (Federal Reserve), and minimums are set by exchanges/FINRA; brokers can impose higher requirements.
– Naked (uncovered) option positions generally carry the highest margin requirements; covered calls, cash‑secured puts, long options, and many defined‑risk spreads have lower or no margin.
– Use brokers’ margin calculators (for example the CBOE Margin Calculator) or the exchange margin manual to get exact figures before trading.
– Failing to meet margin can trigger margin calls and forced liquidations that may close positions at unfavorable prices.
Basics of option margin
1. Purpose of option margin
– For stock and futures margin, the customer is often borrowing to increase buying power. For option sellers, margin is collateral to secure the potential obligation if the option is exercised or moves deeply into the money.
– Margin protects brokers and clearinghouses against counterparty default.
2. Who sets the rules
– Regulation T (Federal Reserve) sets credit rules for broker-dealers.
– Exchanges and FINRA set minimum margin requirements for option positions. Brokers must meet those minimums but can impose stricter rules (higher initial or maintenance margins).
3. Account approval and trading levels
– Brokers typically require customers to request options trading permission and classify approval levels (examples: Level 1 = buy-only options; higher levels = more advanced selling and margin strategies).
– Some strategies (e.g., short naked puts/calls) require margin accounts and higher clearance levels. Portfolio margin accounts (available to qualified accounts) can lower requirements for well-hedged portfolios but require higher account equity and approval.
4. Margin vs. premium received
– When you sell an option you receive premium, which offsets part of the margin requirement (the formulas generally add the premium to the calculated collateral requirement, because the premium is yours but may not cover the entire risk).
How to avoid option margin requirements (practical strategies)
If you want to avoid or reduce margin requirements, consider these approaches:
– Trade long options only
– Buying calls or puts requires no margin (only the premium paid).
– Use covered positions
– Covered call: own 100 shares per call sold. The underlying shares serve as collateral and many brokers require little or no additional margin.
– Covered put or “cash‑secured put”: hold cash equal to the put strike × 100 (or (in some brokers) equivalent margin) to guarantee you can buy the stock if assigned.
– Use defined‑risk spreads
– Vertical spreads (buy one option, sell another of the same type) cap maximum loss to the spread width less net premium received; margin equals the maximum possible loss, typically much lower than naked exposure.
– Use calendar/diagonal spreads or other hedged structures
– Positions where long options offset short option risk reduce required margin.
– Apply for portfolio margin (if eligible)
– Portfolio margin may lower requirements for appropriately hedged multi-position accounts, but has eligibility rules (usually a large equity minimum and approval).
– Reduce position size
– Smaller contracts require less margin.
– Close or hedge positions early
– Exiting a short option or converting to a spread removes or reduces the margin obligation.
Calculating option margin requirements
Important: Brokers may use exchange or firm-specific rules; always verify with your broker’s margin calculator or the exchange margin manual for exact requirements. The CBOE provides a margin manual and calculator that reflect exchange minimums.
General formulas and examples
1) Long options
– No margin required beyond premium paid. Example: you buy a call for $2.00; your cost/margin is $200.
2) Covered calls
– If you own 100 shares and sell one call against it, many brokers do not require additional margin (you must hold the underlying shares). Check broker rules for short-exempt or minimum requirements.
3) Cash‑secured puts
– Hold cash equal to strike × 100 (or an equivalent margin amount). This avoids the unsecured short-put margin.
4) Vertical (defined‑risk) spreads
– Margin generally equals the maximum possible loss: (spread width − net premium received) × 100.
– Example: Sell 60 call and buy 65 call, receive $1.00 premium. Max loss = (65 − 60 − 1.00) × 100 = $400. Margin ≈ $400.
5) Naked (uncovered) equity option (standard formula used by many exchanges)
– For a short naked option on a single equity, exchanges commonly use a formula that requires an initial margin equal to:
100 × [premium + max(20% × S − OTM amount, 10% × S)]
– S = current stock price
– OTM amount = the amount the option is out of the money (for a call: max(strike − S, 0); for a put: max(S − strike, 0))
– The calculation takes the larger of (20% of stock price minus OTM amount) and (10% of stock price), then adds the premium received and multiplies by 100.
– Example (naked short call): Stock price S = $50, strike = $60 (call is out‑of‑the‑money by $10), premium received = $2.00.
– 20% × S = 0.20 × 50 = $10.00
– OTM amount = strike − S = 60 − 50 = $10.00
– 20% × S − OTM = 10 − 10 = $0
– 10% × S = 0.10 × 50 = $5.00 (the max of the two is $5)
– Add premium: 5 + 2 = $7 → multiply by 100 → $700 margin requirement per contract.
Notes on maintenance margin and adjustments
– Exchanges and brokers also enforce maintenance margin levels — after entering a position, adverse moves can trigger a margin call if collateral falls below maintenance. Maintenance calls require immediate deposit or reduction of positions; brokers may liquidate positions without consent to meet margin.
Practical step‑by‑step guide before entering an options trade
1. Identify the strategy and whether you will be long or short options.
2. Determine whether your account has the required options approval level and whether you have a margin account (or portfolio margin) as needed.
3. Check your broker’s margin calculator or the exchange margin manual (e.g., CBOE) to get the exact initial and maintenance margin for your intended position.
4. Compute worst-case exposure for the trade (naked short: use the exchange formula; spreads: use maximum loss; covered/cash‑secured: account for underlying or cash held).
5. Ensure you have sufficient free margin/cash in your account to meet both initial and potential maintenance requirements.
6. Consider alternative hedges or defined‑risk structures if margin ties up capital you need for other trades.
7. Monitor positions actively and set risk limits or exit rules to avoid sudden margin calls.
Consequences of failing to meet margin
– Margin call: broker demands immediate deposit of funds or securities to restore required margin.
– Forced liquidation: if you fail to meet the call, the broker can liquidate positions without prior consent to bring the account into compliance.
– Assignment risk: if a short option is assigned, you must deliver/receive the underlying security; a broker may require extra margin if assignment leads to a large position.
Where to get exact margin figures
– Use your broker’s margin tools and disclosure documents — brokers often have calculators showing initial and maintenance margin for specific combinations of options.
– Use exchange resources such as the CBOE Margin Calculator and the CBOE Margin Manual for exchange minimums and formula details.
– Consult FINRA rules and your broker’s customer agreement for firm‑specific policies.
References and further reading
– Investopedia — Option Margin (source material provided): https://www.investopedia.com/terms/o/option-margin.asp
– CBOE — Margin Manual and Margin Calculator: https://www.cboe.org/margins (or use your broker’s link to the CBOE margin calculator)
– National Archives, Code of Federal Regulations — Part 220 (Regulation T): https://www.ecfr.gov/current/title-12/chapter-II/part-220
– FINRA — Margin Account Requirements: https://www.finra.org/rules-guidance/key-topics/margin
– Your broker’s margin disclosure and options agreement (check for firm‑specific requirements and calculators)
If you tell me the broker you use and the exact option trade you’re considering (underlying, stock price, strike(s), premium, and direction), I can calculate an example initial margin using the standard exchange formulas and show a few alternative margin‑saving structures.