Why is so much margin required when writing an option?
My textbook says that margin is required when options are sold, and that when writing a naked option, the margin is the greater of:
A) A total of 100% of the proceeds of the sale plus 20% of the underlying share price less the amount (if any) by which the option is out of the money
B) A total of 100% of the proceeds of the sale plus 10% of the underlying share price (call) or exercise price (put)
But I thought the whole point of an option is that you can't lose any more money than the option price, since you don't have to exercise it if it's out of the money. So why would the margin ever need to be greater than the option price?
thats only for when you BUY an option...the max you can lose is the $$ paid
BUT
when you sell a naked option, your max loss is unlimited.
imagine you sell a Call with a strike at $20 while the underlying is at $15, and for selling that option, you collect $8 in premium. That's what the buyer of the option paid.
Now imagine the underlying skyrockets to $15,000 and the person you sold the Call option to decides to exercise (when you sell an option...its not your choice...only the buyer of the option has the choice.
So, the owner of the option chooses to exercise...they buy the stock from you and they pay you $20....but you have to go into the market and buy the stock for $15,000 so that you can deliver it to the option owner.
Maybe you collected $8 when you sold the option...but you just lose $15,000 - $20 = $14,980 thanks for playing
Oh so you're saying that the seller of the naked option has to post the margin? But I thought the seller was the dealer. So how would the dealer post margin with himself? Or am I completely misunderstanding
No the dealer / broker is the middleman that matches up the buyer and seller. 3 different parties here.
oh okay, sorry. that makes sense then.
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