Q & A. Margin; Rolling

Dear Mark:

I have been reading several books on options and I have learned a lot, but there are a few questions I have that I still do not completely understand, I hope you are able to help me out!

1) First of all, with writing uncovered puts/calls what are the requirements with major brokerages on this? How much in funds do you need and what do they require of you to be able to trade uncovered?

2) I have been learning about rolling strategies and how if you write an uncovered put if the stock price is currently at 15 and your strike is at 12.5, and if the stock drops to 12.5 or below to avoid exercise you can roll the option. Is there anything else I should know about rolling or can you help be better understand it?

Mike

1) Each broker is allowed to set its own margin requirements, as long as they are not lower that SEC mandates.  The best answer is for you to go to your broker's website.  I know the answer will be there.

Here is a link to Interactive Broker's Margin page.

Selling uncovered calls is considered to be so risky that most brokers will not allow any customer to adopt that strategy.  Others limit it to their most experienced traders.  Selling naked puts is allowed by most, but not all brokers.  Thus, there are no specific requirements.  Your broker will decide.

When selling uncovered options, the margin requirement is

  • The cash you collected when selling the option. Plus
  • 20% of the stock price. Minus
  • The OTM (out of the money) amount.
  • Minimum margin $250

Thus, with stock at 80 and the 70 put at 2 (or the 90 call at 2), the margin requirement for selling either option (any month) is:

 $200 + 0.2 * 8000 – 1000 = $800

2) Yes.  There is much you should know. First, rolling is an over used method.  Too many traders believe that if they can roll a position to a lower strike price and a more distant expiration – and if they can collect a cash credit for the trade, that all is well.

It's true that rolling as described gives the trader a decent chance to escape the trade with a profit, and that possibility makes the trade look attractive when it is not.

To me, you should roll the position, ONLY when you like the new position and would consider opening it on its own merits, and not because you happened to roll into it.  For example, if you decided to cover the Mar 12.5 put and roll it into the Sep 10 put for a cash credit of $0.50, that might 'feel' good.  But unless you want to be naked short the Sep 10 put in a stock that has been moving steadily lower, it's much better to simply take your loss on the Mar 12.5 put and find another investment.

Most beginners believe that avoiding a loss is a great idea.  It's not.  You must learn to manage risk – and that means not continuing to hold losing trades with the hope that the stock will turn around and all will be well.  Those small losers can turn into huge losers. 

You are usually better off with a new stock.  After all, it should not matter which stock gives you profits.  What matters is making those profits while keeping risk at reasonable levels.

You must also understand that although calls are seldom exercised prior to expiration (except to collect a dividend), it's not uncommon to be assigned an exercise notice on short put options before expiration.  That happens when the put has moved far into the money.  Hopefully you are not still short that put if the stock drops to 8, but just be aware that it is possible to be assigned – before you roll.  Once assigned, the process cannot be reversed.

209

2 Responses to Q & A. Margin; Rolling

  1. rluser 01/10/2009 at 2:43 PM #

    This post goes a long way towards clarifying for me what you mean at a couple points in “The Rookie’s Guide to Options” where you mention overuse or abuse of rolling.

  2. Mark Wolfinger 01/10/2009 at 9:49 PM #

    Rolling is appropriate in some circumstances.
    As you now understand, too many investors roll just to ‘do something.’ Often it’s better to accept the fact that a specific trade turned out to be a money loser.