Options Margin

Options Margin Fundamentals

Margin requirements for options differ significantly from equity margin requirements. The Registered Options Principal must understand these differences to properly supervise margin accounts, prevent violations, and protect both customers and the firm from excessive risk exposure. Options margin is governed by Federal Reserve Board Regulation T, exchange rules, FINRA rules, and individual firm policies.

Unlike equity securities where margin is primarily used to purchase securities on credit, options margin serves as collateral or a performance bond to ensure the customer can fulfill the obligations associated with their options positions. This is particularly important for short (written) options positions, which can expose the customer to substantial or unlimited losses.

Key Margin Concepts for Options

• Long Options: Cannot be purchased on margin. Customers must pay 100% of the premium in cash. Long options have no loan value and cannot be used as collateral.
• Short Covered Options: Have reduced or zero margin requirements because the position is hedged by ownership of the underlying security or another offsetting option position.
• Short Uncovered Options: Require substantial margin deposits because of the risk of significant loss. These are the positions where ROPs must exercise heightened supervision.
• Spread Positions: Often have reduced margin requirements because the long position in one option offsets some of the risk of the short position in the related option.

Regulation T and Options Margin

Federal Reserve Board Regulation T sets the minimum margin requirements for options trading. Individual firms and exchanges may impose stricter requirements, but they cannot be more lenient than Regulation T. The ROP must ensure that the firm's margin policies meet or exceed regulatory minimums.

Regulation T Initial Requirements

Under Regulation T, the initial margin requirement for equity purchases is 50% of the purchase price. However, options have different treatment:

• Long Options: Must be paid for in full (100% of premium). No margin credit is extended.
• Short Equity Options: The customer must deposit the margin required for a short stock position (typically 50% of the underlying stock value) plus the option premium received, minus any out-of-the-money amount (but the total requirement cannot be less than 10% of the underlying stock value plus the premium).
• Covered Calls: No additional margin beyond the requirement to own or margin the underlying stock. The stock can be held in a cash or margin account.
• Covered Puts: The customer must have sufficient cash or short stock position to cover assignment.

Covered vs Uncovered Positions

The distinction between covered and uncovered options positions is critical for margin calculations and risk assessment. The ROP must ensure that positions are properly classified and margined.

Covered Options Positions

A covered position occurs when the customer owns an asset or has a position that offsets the risk of the short option. Covered positions have significantly lower or zero margin requirements:

• Covered Call: Customer owns 100 shares of the underlying stock (or an equivalent long position such as a LEAPS call) for each call written. No additional margin is required beyond the equity margin on the stock itself.
• Covered Put: Customer has sufficient cash set aside to purchase the stock at the strike price if assigned, or holds a short stock position. For cash-secured puts, the customer must maintain cash equal to the strike price × 100 shares.
• Covered Combination: Both the call and put sides are covered by appropriate hedges.

Uncovered Options Positions

Uncovered (naked) positions expose the customer to substantial or unlimited risk. These positions require significant margin deposits and heightened supervisory scrutiny:

• Uncovered Call: Customer does not own the underlying stock. Potential loss is theoretically unlimited as the stock price can rise indefinitely.
• Uncovered Put: Customer does not have cash or short stock to cover assignment. Maximum loss is substantial (strike price minus premium received, multiplied by 100).
• Uncovered Straddle/Strangle: Writing both calls and puts without covering both sides. Only one side is margined (the side with greater requirement), plus the premium received on the other side.

Strategy-Based Margin Requirements

Different options strategies have distinct margin treatments. Understanding these requirements is essential for the ROP to properly supervise customer accounts and prevent margin violations.

Spread Strategies

Spread strategies involve simultaneous long and short positions in related options. Because the long option provides some offset to the short option, margin requirements are typically reduced:

• Vertical (Price) Spreads: Same expiration, different strikes. The margin requirement is the maximum potential loss of the spread. For a bull call spread or bear put spread (debit spreads), the margin is the net premium paid. For a bear call spread or bull put spread (credit spreads), the margin is the difference between strikes minus the net premium received.
• Horizontal (Time) Spreads: Same strike, different expirations. Treated as a long option (requiring full payment) and a short option (requiring margin for the uncovered position).
• Diagonal Spreads: Different strikes and expirations. Margined similarly to horizontal spreads unless the long option has equal or greater time value than the short option, in which case it may receive more favorable margin treatment.

Straddles and Strangles

Short straddles and strangles involve writing both a call and a put. Since the stock cannot move in both directions simultaneously, only one side is margined:

• Calculate the margin requirement for the short call
• Calculate the margin requirement for the short put
• The total margin requirement is the greater of the two, plus the premium received on the other side

Collars and Protective Strategies

Collars combine stock ownership with options positions to limit risk:

• Collar: Long stock + long put + short call. The long put provides downside protection while the short call is covered by the stock. Margin requirement is only for the stock position.
• Protective Put: Long stock + long put. The put must be paid in full (100% of premium). The stock is margined normally.
• Protective Call: Short stock + long call. The call must be paid in full, and the short stock is margined according to short stock rules.

Portfolio Margin vs Strategy-Based Margin

Most retail options accounts use strategy-based margin (also called Regulation T margin or rules-based margin), which applies fixed formulas to specific strategies. However, eligible customers with larger accounts may qualify for portfolio margin, which can significantly reduce margin requirements for hedged positions.

Strategy-Based Margin (Reg T)

Strategy-based margin applies standardized formulas regardless of overall portfolio risk:

• Simple calculation methodology
• Fixed percentages (typically 20% for equity options)
• Applied position-by-position
• Does not consider overall portfolio correlation
• Available to all margin-approved customers

Portfolio Margin

Portfolio margin calculates requirements based on the theoretical risk of the entire portfolio under various market scenarios:

• Eligibility Requirements: Minimum account equity of $150,000 (increased from $125,000), approval for uncovered options writing, and firm approval after suitability determination
• Risk-Based Calculations: Uses theoretical pricing models to calculate potential losses across a range of market scenarios (typically ±15% moves in the underlying)
• Reduced Requirements for Hedged Positions: Recognizes that offsetting positions reduce overall portfolio risk
• Increased Monitoring Obligations: The ROP must implement enhanced monitoring procedures for portfolio margin accounts, including real-time risk assessment and stress testing

When Portfolio Margin Increases Requirements

While portfolio margin often reduces requirements for hedged positions, it can increase requirements for:

• Concentrated positions in a single underlying security
• Positions with significant gap risk (around earnings or events)
• Highly leveraged positions without hedges
• Volatile underlying securities where theoretical losses in stress scenarios are substantial

Maintenance Requirements

After a position is established, the customer must maintain minimum equity in their account. If equity falls below the maintenance requirement, a margin call is issued. The ROP must supervise the firm's margin call procedures to ensure timely and appropriate action.

Minimum Maintenance Requirements

FINRA and exchange rules establish minimum maintenance requirements:

• Long Stock: 25% of current market value (FINRA minimum; firms often require 30% or more)
• Short Stock: 30% of current market value (minimum $5 per share)
• Long Options: No maintenance requirement (position has no loan value and must be fully paid)
• Short Uncovered Options: Daily recalculation using the same formula as initial margin (20% of stock value + premium - OTM amount, minimum 10% + premium)
• Covered Calls: Maintenance on the underlying stock only
• Spreads: Maximum loss of the spread

Mark-to-Market and Daily Recalculation

Options positions are marked to market daily. This means:

• Short option positions are revalued at the current market price of the option
• The underlying stock price is used to recalculate margin requirements
• If the account equity falls below the maintenance requirement, a margin call is generated
• The ROP must ensure the firm has systems in place to identify margin deficiencies promptly

Margin Calls and Timeframes

A margin call occurs when the equity in a customer's account falls below the required maintenance level. The ROP must ensure that margin calls are issued promptly and that the firm has clear policies for meeting or liquidating deficiencies.

Types of Margin Calls

• Initial Margin Call: Issued when a customer wants to establish a new position but lacks sufficient equity. The customer must deposit the required initial margin before the trade can be executed.
• Maintenance Margin Call: Issued when account equity falls below the maintenance requirement due to adverse market movements. Also called a "house call" or "maintenance call."
• Regulation T Call: Federal call when the customer has not met the initial Regulation T requirement within the required timeframe (typically by settlement date).

Meeting Margin Calls

Customers can meet margin calls by:

• Depositing Cash: Most direct method; immediately increases account equity
• Depositing Marginable Securities: Transfers stock or other marginable securities into the account (valued at their loan value, typically 50% for equity)
• Closing Positions: Selling long positions or buying to close short positions to reduce margin requirements
• Liquidation by Firm: If the customer does not respond, the firm may liquidate positions without further notice to meet the deficiency

Timeframes for Margin Calls

• Regulation T Calls: Must be met by settlement date (T+1 for options, T+2 for equity). If not met, the position must be liquidated and the account may be restricted for 90 days.
• Maintenance Calls: Must typically be met "promptly" (firms often specify same-day or next-day). Firms have discretion but must act reasonably to protect themselves and customers.
• House Calls: Firms may set their own timeframes for house maintenance requirements that exceed regulatory minimums.

ROP Supervisory Obligations for Margin Compliance

The Registered Options Principal has specific supervisory responsibilities related to margin compliance. These obligations are designed to protect customers, ensure firm safety and soundness, and maintain market integrity.

Key ROP Responsibilities

• Written Supervisory Procedures: Establish, maintain, and enforce comprehensive WSPs covering margin requirements for all options strategies, margin call issuance and follow-up, position limits, and account monitoring.
• Daily Review: Review margin exception reports daily to identify accounts in deficiency. Ensure timely issuance of margin calls.
• Position Concentration Monitoring: Monitor for accounts with concentrated positions that could lead to outsized margin requirements if the market moves adversely.
• Pre-Approval of High-Risk Positions: Many firms require ROP pre-approval before customers can establish uncovered positions, especially in volatile securities or around known events (earnings, FDA approvals, etc.).
• Intraday Monitoring for Portfolio Margin: Accounts using portfolio margin require more frequent monitoring, often including real-time or intraday margin checks during periods of high volatility.
• Training and Education: Ensure that registered representatives understand margin requirements and can explain them to customers. Reps should warn customers of margin risks before executing high-risk strategies.
• Escalation Procedures: Establish clear procedures for escalating margin deficiencies that are not promptly cured, including when to liquidate positions.

Common Margin Violations

The ROP must be vigilant for these common margin compliance failures:

• Allowing customers to trade without sufficient margin
• Failing to issue margin calls promptly when deficiencies occur
• Permitting customers to repeatedly fail to meet margin calls without consequences
• Incorrectly calculating margin requirements for complex strategies
• Failing to properly classify positions (e.g., treating an uncovered position as covered)
• Not monitoring concentrated positions in portfolio margin accounts
• Allowing pattern violations where customers routinely trade first and deposit margin later