Intermediate Options Strategies

Top Five Things Traders Need to Know About Option Margin

The truth is, unlike margin on futures contracts, option margin is dynamic.  It is almost constantly changing along with market price, volatility, and the exchange’s perceived event risk.  Further, many brokerage firms opt to charge their clients margin requirements that are higher than the exchange minimums to compensate for what they believe to be additional risk posed to the client, and more importantly themselves.  Accordingly, one will probably never fully understand option margin but it is worthwhile to be aware of the basics to ensure proper strategy development and implementation. 

According to the, Standard Portfolio Analysis of Risk, commonly known as SPAN, is a “sophisticated methodology that calculates performance bond requirements by analyzing the “what-ifs” of virtually any market scenario.”  SPAN was developed and implemented in 1988 by the Chicago Mercantile Exchange; it is now owned and operated by the CME Group (the mega-conglomerate of U.S. futures exchanges).  It is now the industry standard for risk calculation and, therefore, represents the exchange minimum margin requirement for options and futures trades. 

SPAN is the commodity equivalent of “portfolio margining” in stock trading

The beauty of SPAN is that it accounts for a traders’ portfolio of holdings rather than margining each position individually.  This means that traders executing antagonistic trades will receive a margin break.  For instance, a trader buying an S&P 500 futures contract and then selling a call option against it, can only lose on one leg of the trade or the other, but not both. This is because the positions benefit in the opposite outcome.  Similarly, a trader that sells both a call and a put, will not be charge full margin on both sides of the trade because it would be impossible to lose on both the call and the put.  As a result, such trades are margined at a lower rate than would be the case if the exchange ignored the correlation of positions and charged full-margin on each.

Stock traders are likely aware of a method of brokerage firm risk assessment known as “portfolio margining”.  Similar to SPAN, clients enjoying portfolio margin calculations in their stock account are provided discounts when holding positions that can be considered hedges to one another.  However, stock traders will also tell you that gaining access to such a margining system requires a little work, and a decent amount of money.  Brokerage firms typically won’t offer this luxury to clients trading accounts less than $100,000.

Futures and options traders, on the other hand, are offered portfolio margining in the form of SPAN, regardless of account size.  This is assuming their brokerage firm honors SPAN minimums; we’ll get into that shortly.  

SPAN margin should be a starting point when determining account funding

The goal of SPAN is to evaluate the risk of a particular trading account by calculating the “worst” possible loss that could reasonably incur in a single trading day.  However, most industry insiders agree that SPAN becomes less accurate as the strikes price of the options in question get deeper-out-of-the-money.  Additionally, there is no such thing as a worst case scenario because we truly don’t know how extreme market prices can get in any given trading session.  Of course, the odds of such extremes occurring are rare, but anything is possible.  For instance, on May 10th 2010 the S&P 500 futures dropped further and farther than SPAN had accounted for.  Traders who were fully margined going into the day, discovered that losses not only surpassed their daily margin requirement but, in many cases exceeded their account balance! 

Accordingly, traders shouldn’t assume their SPAN margin requirement is necessarily the worst case scenario.  Instead, traders should leave plenty of excess margin in their account to provide a cushion to something beyond SPAN’s assumption of the “worst case scenario”.

I recommend that clients attempt to keep the margin used in their account to 50% of the total account balance, or less.  Thus, a client trading with a $10,000 account could comfortably hold positions that require $5,000 or less in margin.  Unfortunately, most traders view excess margin as a wasted opportunity.  As a result, they will try to use all $10,000 of their $10,000 trading account in margined trades. This practice will almost always end in ruin, or at least frequent margin calls and necessary action to alleviate them.n 

Here are five things to know about margin and options

1. Not all option strategies are limited risk

Some might be wondering why we are talking about margin and options in the same context.  The assumption that there is no margin on options, because the risk is limited, is a false one for those trading options in any other capacity than simply buying them outright, or buying limited risk option spreads. 

Traders selling options as credit spreads, or outright (naked), are subject to margin requirements.  This is because, similar to futures trading, option sellers are often facing theoretically unlimited loss potential.  Accordingly, it is necessary for exchanges and brokerage firms to ensure that option sellers are able to meet their obligations to the trading community should something go wrong.  This assurance comes in the form of a performance bond, or simply a margin requirement. 

2. Not all broker, and brokerage firms, charge SPAN minimum margin

Earlier in this article we pointed out that all futures and options traders receive portfolio margining despite account size.  This is only partially true because not all brokerage firms pass the SPAN calculated margin on to their clients.  Some believe it is in the best interest of their clients, and themselves, to charge a higher margin deposit than is required by SPAN. 

When a brokerage firm “pads” their margin requirement, it is generally done as a percentage of SPAN.  A common practice among these types of brokers is to charge 30% above SPAN.  In other words, if the SPAN margin requirement is $2,000, a brokerage practicing a 30% “up-charge” would require you to have $2,600 to hold the same position a client at a different firm could hold for $2,000. 

It is up to each trader to determine whether this is acceptable or not, but my general opinion is that it isn’t.  Option traders might go months, or years, without an incident but if volatility flares up the additional margin charged to you by your brokerage firm might mean the difference between being forced out of a position prematurely and riding the wave to eventually (potentially) reap the rewards. 

3. Not all brokers, and brokerage firms, allow option selling

Option selling isn’t necessarily a popular strategy among the risk managers of brokerage firms.  In fact, not all brokers will allow clients to sell options, or even trade option spreads.  The most common reasoning firms use when forbidding clients to sell options is a belief that such a strategy exposes traders to open-ended risk.  Although this is true (naked option sellers face theoretically unlimited risk and limited reward); the same risks are faced by futures traders.  In my view, the difference in acceptance has little to do with unlimited risk, and more to do with the complexity of options, and the difficulty inexperienced brokerage firms have in dealing with the risk short option trading clients bring to brokerage firms.  Quite frankly, in some instances the anti-option selling friendly attitude of commodity brokers is a simple case of lazy.

Futures and options traders can, in extreme market environments, lose more money than is on deposit.  When that happens, it is the brokerage firm that is responsible for meeting the client’s obligation with the exchange, at least until the client pays the money owed.  Therefore, brokers and brokerage risk managers, take steps to avoid clients from putting them in an unfavorable situation (by losing more money than they have in their trading account).  Some firms believe it is easier to forbid option trading, or at least restrict it, than it is to take the time to learn and employ proper risk management of option trading clients.

Despite the bad rap sheet, option selling can be a relatively higher probability trading strategy and one that exposes both clients and brokerage firms to less risk than futures trading.  If your brokerage firm doesn’t allow you to trade options in conjunction with your futures positions, it’s probably time to look for a broker that will provide an optimal trading environment for its clients, as opposed to seeking the most convenient arrangement for itself.

4. Some brokerage firms will force liquidate your option trades at the hint of trouble

There are brokerage firms that will allow you to execute option spreads, and sell naked options, but won’t give you the opportunity to manage risk on your own.  It isn’t uncommon for discount brokerage firms to force liquidate client positions without providing notification, or even a reasonable excuse.  Specifically, traders at discount firms have learned the hard way that even in the absence of a margin call,  and a lack of immediate risk of losing more money than is on deposit, it is possible a brokerage firm offset their positions simply because the risk manager became “uncomfortable”. 

Unnecessary premature liquidation of option trades can be an extremely expensive and emotionally painful ordeal. 

Even the most responsible traders will trigger margin calls from time to time.  However, there are often ways to alleviate margin calls without liquidating positions, or sending money.   Because SPAN margin accounts for the overall portfolio, sometimes buying or selling futures contracts, or buying or selling options, can do the trick. 

If a margin call is triggered in your account, contact your broker for ideas.  An experienced broker will be able to guide you out of most margin calls without interfering with your overall position.  Further, many trading platforms have margin calculators built in.  Play around with various adjustments to determine what your “options” might be to confront a margin shortage.

5.When selling options, be sure to put yourself in the right environment for your needs

Option selling, or option spread trading, can only be effective if you are trading with a brokerage firm that is knowledgeable and friendly to such strategies.  It is imperative that you are provided with a fair margining system, and proper treatment in times of emergency.   Before implementing an option selling strategy, you should confirm with your broker their policy on SPAN margining and providing leeway for margin calls to be met.

*There is substantial risk in trading options and futures.  It is not suitable for everyone. 


Carley Garner is the Senior Strategist for DeCarley Trading, a division of Zaner, where she also works as a broker.  She authors widely distributed e-newsletters; for your free subscription visit  Her books, “A Trader’s First Book on Commodities,” “Currency Trading in the FOREX and Futures Markets,” and “Commodity Options,” were published by FT Press.

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