Margin trading vs option trading

Option Margin.

What is the 'Option Margin'

The option margin is the cash or securities an investor must deposit in his account as collateral before writing options. Margin requirements vary by option type. Margin requirements are established by the Federal Reserve Board in Regulation T; individual brokers may impose additional requirements. Brokers require investors to deposit margin funds because they may be needed to buy or sell underlying stocks if the options are exercised. They may also be needed to close losing positions.

BREAKING DOWN 'Option Margin'

Margin requirements for options trading are different from margin requirements for trading stocks or futures. Also, some options trading strategies have no margin requirement. This is because the underlying stock can be used as collateral. Neither covered calls nor covered puts have a margin requirement, for example.

Margin Trading: The Advantages.

Margin trading allows you to.

Leverage your gains.

Buying shares on margin enables you to leverage your gains by enabling you to buy more shares than you could if you were doing so on a cash-only basis. The example below demonstrates how buying shares on margin can enable a return on investment that is almost double the return obtained without using margin. (Related: Leveraging Leverage For Bigger Profits)

Take advantage of trading opportunities.

Trading shares on margin allows you to take advantage of trading opportunities as they arise, without having to raise cash by divesting your existing investments or from other sources.

Diversify your portfolio.

Used judiciously, a margin account can be used to effectively diversify or hedge your portfolio. For example, if you are too heavily concentrated in a few stocks or sectors, your margin account can be used to add positions in other stocks or sectors in order to improve diversification. Or if you already own a diversified portfolio and wish to hedge downside risk, you can short sell the broad market or specific sector, or use options for hedging. Recall that short selling, and certain types of options trades, can generally only be done in a margin account (short selling carries its own risks – refer to our Short Selling Tutorial ).

“Carry” trades.

A carry trade refers to borrowing at a lower interest rate and investing in an instrument that can generate higher returns. While currency carry trades are widely used in the currency market, an astute investor can use it effectively in the stock market as well. For example, assume an investor with $50,000 to invest takes on margin debt of $50,000 and invests the full amount in a diversified portfolio that yields 12%. If the interest rate on the margin loan is 8.50%, the investor generates an additional 3.50% (or $1,750) on the overall portfolio, compared to the return on the cash-only or unleveraged portfolio.

Full Explanation of Margin.

Margin is a very widely used word in financial terms, but it's unfortunately a word that is often very confusing for people. This is largely because it has a number of different meanings, depending on what context it is being used in. In particular, the meaning of the term as used in options trading is very different to the meaning of the term as used in stock trading.

The phrase profit margin is also a common term, and that means something else again. On this page we explain what the term margin means in these different contexts, and provide details of how it's used in options trading.

Profit Margin Margin in Stock Trading Margin in Futures Trading in Options Trading Standard Portfolio Analysis of Risk.

Profit Margin.

Profit margin is a term that is commonly used in a financial sense in a variety of different situations. The simplest definition of the term is that it's the difference between income and costs and there are actually two types of profit margin: gross and net.

Gross profit margin is income or revenue minus the direct costs of making that income or revenue. For example, for a company that makes and sells a product, their gross profit margin will be the amount of revenue they receive for selling the product minus the costs of making that product. Their net margin is income or revenue minus the direct costs and the indirect costs.

Investors and traders can also use the term profit margin to describe the amount of money made on any particular investment. For example, if an investor buys stocks and later sells those stocks at a profit, their gross margin would be the difference between what they sold at and what they bought at. Their net margin would be that difference minus the costs involved of making the trades.

Profit margin can be expressed as either a percentage or an actual amount. For example, if you made $10 profit from a $100 investment your profit margin would be $10 or 10%.

Margin in Stock Trading.

You may hear people refer to buying stocks on margin, and this is basically borrowing money from your broker to buy more stocks. If you have a margin account with your stock broker, then you will be able to buy more stocks worth more money than you actually have in your account. For example, if you have $10,000 in your account, then you may be able to buy up to $20,000 worth of stock.

If you do buy stocks in this manner and they go down in value, then you may be subject to a margin call, which means you must add more funds into your account to reduce your borrowings. Margin is essentially a loan from your broker and you will be liable for interest on that loan. The idea of buying stocks using this technique is that the profits you can make from buying the additional stocks should be greater than the cost of borrowing the money. You can also use margin in stock trading to short sell stocks.

Margin in Futures Trading.

Margin in futures trading is different from in stock trading; it's an amount of money that you must put into your brokerage account in order to fulfill any obligations that you may incur through trading futures contracts. This is required because, if a futures trade goes wrong for you, your broker needs money on hand to be able to cover your losses.

Your position on futures contracts is updated at the end of the day, and you may be required to add additional funds to your account if your position is moving against you. The first sum of money you put in your account to cover your position is known as the initial margin, and any subsequent funds you have to add is known as the maintenance margin.

Margin in Options Trading.

In options trading, margin is very similar to what it means in futures trading because it's also an amount of money that you must put into your account with your broker. This money is required when you write contracts, to cover any potential liability you may incur. This is because whenever you write contracts you are essentially exposed to unlimited risk.

For example, when you write call options on an underlying stock you may be required to sell that stock to the holder of those contracts. Assuming that you don’t own the necessary stock, you would then have to purchase it from the open market at whatever price it happened to be trading at. If it was trading at a significantly higher price than the strike price of the contracts you had written, then you would stand to lose large sums of money.

In order to ensure that you are able to cover that loss, you must have a certain amount of money in your trading account. This allows brokers to limit their risk when they allow account holders to write options because when contracts are exercised and the writer of those contracts is unable to fulfill their obligations, it's the broker with whom they wrote them that is liable.

Although there are guidelines set for brokers as to the level of margin they should take, it's actually down to the brokers themselves to decide. Because of this, the funds required to write contracts may vary from one broker to another, and they may also vary depend on your trading level. However, unlike the requirements when trading futures, the requirement is always set as a fixed percentage and it isn't a variable that can change depending on how the market performs.

It's actually possible to write options contracts without the need for a margin, and there are a number of ways in which you can do this. Essentially you need to have some alternative form of protection against any potential losses you might incur. For example, if you wrote call options on an underlying stock and you actually owned that underlying stock, then there would be no need for any margin.

This is because if the underlying stock went up in value and the contracts were exercised you would be able to simply sell the holder of the contracts the stock that you already owned. Although you would obviously be selling the stock at a price below the market value, there is no direct cash loss involved when the contracts are exercised. You could also write put options without the need for a margin if you held a short position on the relevant underlying security.

It's also possible to avoid the need for a margin when writing options by using debit spreads. When you create a debit spread, you would usually be buying in the money options and then writing cheaper out of the money options to recover some of the costs of doing so. For example, you could buy call options on Company X stock with a strike price of $20 and then write call options on Company X stock with a higher strike price. Assuming you buy the same amount of contracts as you write, your losses are limited and there is therefore no need for margin.

There are a number of trading strategies that involve the use of debit spreads, which means there are plenty of ways to trade without the need for margin. However, if you are planning on writing options that aren't protected by another position then you need to be prepared to deposit the required amount of margin with your options broker.

Standard Portfolio Analysis of Risk.

The Standard Portfolio Analysis of Risk, known as SPAN, is a method used for working out the margin requirements for futures, and futures options. Unless you are trading using futures options, then this will have absolutely no bearing on you because it doesn’t apply to other types of options such as stock options or index options. In reality, even if you are trading futures options this isn't something you really need to concern yourself with. However, you may hear the term used and it can be useful to know what it is.

The SPAN system was developed by the Chicago Mercantile Exchange in 1988, and is basically an algorithm that's used to determine the margin requirements that brokers should be asking for based on the likely maximum losses that a portfolio might incur. SPAN calculates this by processing the gains and losses that might be made under various market conditions. As we have mentioned, it's far from essential that you understand SPAN and how it's calculated, but if you do trade futures options then the amount of margin your broker will require will be based on the SPAN system.

Margin trading vs options trading. Trading in a margin account would allow you to use unsettled funds; this will avoid all the settlement date related violations that could happen in a cash account. Certain trading behaviors are allowed only in margin accounts, such as; short-selling, day-trading, and advanced option strategies. Trading in a margin account.

What is Margin?

Margin trading vs options trading. Dollar to dollar, which method of trading will make the most profit with a stock like GOOG for a $ account? 1) Options (broker doesn't let you use.

In the stock market, to trade on margin means to purchase or short stock on credit. Margin customers are required to keep securities on deposit with their brokerage firms as collateral for their borrowings. Equity options and equity index options can now be purchased on margin, provided they have more than nine 9 months until expiration. In options trading however, "margin" also refers to the cash or securities required to be deposited by an option writer with his brokerage firm as collateral for the writer's obligation.

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time Cash dividends issued by stocks have big impact on their option prices.

This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement.

In place of holding the underlying stock in the covered call strategy, the alternative Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk.

A most common way to do that is to buy stocks on margin Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions.

They are known as "the greeks" Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account.

You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service.

Toggle navigation The Options Guide. Overview Conversion Reversal Dividend Arbitrage. The financial products offered by the company carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.