How Does Options Margin Work? | Financial Derivatives | Options Trading Lessons

These classes are all based on the book Trading and Pricing Financial Derivatives, available on Amazon at this link.

Hello welcome back to my youtube channel my name is patrick boyle if this is the first video you’re watching do hit the subscribe button in this video we’re going to learn all about options margin who pays it and why and how it changes over the life of an option okay so let’s get get into it so the first thing we’re going to talk about is options margin and what

Is it so options margin is a bit like i did a video a little bit earlier on futures margin which you may have seen and in that video we explained how buyers and sellers of futures have to put up a certain amount of money but we call margin and that’s put up at the clearinghouse in order to make sure that the both the buyer and the seller of the future are able to

Meet their financial obligations should the market move against them now similarly with options we have a clearinghouse and we have a margin requirement now it’s worth noting that options margin is quite a bit different futures margin simply because only one side of the transaction has to put up margin so let’s talk about why that might be well with with an option

We’ll say a call option the buyer of a call option pays an amount of money we call the option premium and that gives them the right but not the obligation to either buy or sell the underlying depending on if it’s a call or a player option the expiration date now the most that the buyer of an option can lose is the amount of money that they spent on premium and they

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Pay that upfront when they buy the option right that’s the first thing they do they buy the option they pay the premium they can’t actually lose more than that so it’s not reasonable to ask to post an additional margin simply because they’ve already put up an amount of money that is their maximum loss right so for the buyer of an option via the pod put option or a

Call option they just paid the premium and that’s all they have to pay there’s no additional margin now for sellers of these options the problem is that if you sell an option you can actually lose more money than the amount of premium that you received and so you have to put up an additional amount of money so the seller of a pud oracle option will have to put up

Money that is there to show that they’re able to meet their obligation should that option be exercised now the next thing that we should talk about is the idea of hedged are naked option sellers now if you’re selling an option you might already have a position an offsetting position in the underlying you might be a hedge er who is selling an option and if you’re

Doing that we’ll say for example if you own the underlying and you’ve sold a call option even though the price of the underlying can go up and up and up and that will lose you money on your short call option imagine losing on the option you’ll be making on being long the underlying and so that’s what we call a covered position and if you have a covered position

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Like that your margin requirement will be significantly lower than if you are a naked option seller now what we mean when we say a naked option seller is someone who has sold an option and they don’t have an offsetting position in the underlying so in a situation like that where their losses are potentially unlimited they’re going to have to show that they’re able

To meet their obligation so they’re going to have to put up margin and should the price move against them they’re going to have to increase the amount of margin so there’s an initial margin requirement which is the amount that you’re required to put up in order to sell the off and it all begin with and then there’s what’s called maintenance margin which is the

Minimum level you have to keep your account at the minimum amount of margin that you must keep in your account if you fall below that level you get what’s called a margin call which is a phone call from your broker telling you that you need to wire in money right away in order to meet the maintenance margin level now if you don’t do that you will be knocked out

Of your position basically that the broker will will buy back that option at the market and you will sustain whatever loss occurs based upon that transaction and so usually but when i said that you have to send the money and you usually have to wire the money in for that day settlement you don’t get a day or two you can’t post them a check right you have to get

The money and before the market closes that day otherwise you’re out of your of your position and so so anyhow that is options margin it’s an amount of money that a trader either you just the seller of either put or call options has to put up in order to in order to be in the position now that will change based upon changing market conditions the the exchanges

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Have a formula they don’t actually disclose what the formula is but they have a formula that they used to calculate the margin for various options and it changes on a daily basis that the margin requirement changes on a daily basis and so for example if the market gets more volatile that means that you’ll have to put up more margin so even if the will say if the

Underlying moved around but ended up right where it started but the market is not the implied volatility in the market is higher you will be required to post additional margin in order just to stay in that position so margin is there really to you know to protect the both sides really often they can’t to make sure that these contracts all get paid off and to protect

The brokers and so on and so that is options margin if you found this video useful please do subscribe to hit the like button and if you’d like to learn more i do have a book that i’ve written on this topic called trading and pricing financial derivatives and there is a link to that book in the in the description below have a great day and talk to you later bye

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How Does Options Margin Work? | Financial Derivatives | Options Trading Lessons By Patrick Boyle

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