Selling Options & Margin Requirements
A stock option is a contract between a buyer and a seller that gives the buyer the right, but not the obligation, to buy or sell the stock the contract is written on, on a specific date in the future, at a price agreed upon today. If you sell, or write, an option contract, you incur an obligation to honor the contract if the buyer chooses to exercise it on the date the contract expires.
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Selling Option Contracts
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When you buy a stock option, your risk is limited to the contract's premium price that you bought it for. When you sell a contract, you stand to lose more money than you have in your brokerage account, which can potentially put your broker at risk too. Because of this risk to your broker, special margin restrictions are placed on the practice of option writing.
Option Margin
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Margin is money you can borrow from your broker. When you use brokerage margin, money and securities held inside your account are used as collateral for the loan. When you sell option contracts, you do not actually borrow money from your broker, but because of the risk to your broker, you will be required to keep a certain amount of money or securities in your account that will be used as collateral protecting your broker against potential future losses.
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Calculating Option Margin
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Margin rules for writing stock options can be complex and the collateral requirements vary based on the type of selling strategy you use. The Chicago Board of Exchange provides a margin calculator on their website that can help you calculate the amount of collateral you must keep in your account based on the strategy you wish to use and other related factors. Keep in mind that your broker may have additional restrictions not required by the CBOE.
Covered Versus Uncovered Options
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If you own the stock you write a contract on, the contract you write is considered covered by the stock in your account. In this instance, your risk is limited. At worst, the option buyer will force you to sell your stock to them. If you write an uncovered contract, your risk, and the risk you expose your broker to, is much higher because you may be forced to go out and buy stock on the open market to meet your contract obligation. Thus, margin requirements for writing uncovered contracts are much stricter than they are for writing covered contracts.
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