Q and A. How Much Cash Needed to Sell Options?

Mark,

How much cash float should an option seller keep in case of emergency, and where to keep it?

JR,

I'm hoping this is a theoretical question, and that you don't plan to sell naked options and hold the positions with no thought of exiting, the trade if things get ugly.  If you exercise reasonable risk management, you should never need the full amount that approximates the total set aside.

It's okay to keep cash in your brokerage account because you must meet margin requirements, or else you will not be allowed to hold these positions.  If you have excess cash over margin requirements, these days, there's no good place to put that cash.  Rates are too low.  When interest rates are higher, money market funds are very liquid and thus, a reasonable choice.

1) If you sell naked calls (not allowed by many brokers), potential losses are unlimited.  Thus, you can never keep enough cash on the sidelines.  As a practical consideration, I suggest maintaining enough to cover losses if the stock doubles in price.

2) When you sell naked puts – a decent strategy if your objective is to slowly accumulate stocks for your portfolio – I always recommend making those put sales 'cash secured.'  That translates into holding enough cash to enable you to purchase the stock, if you are assigned an exercise notice.

Thus, if you sell 10 puts with a strike price of 30 and collect $200 for each put, you should keep $28,000 cash on hand ($30,000 minus $200 for each put sold).

3) When you sell call spreads, put spreads, or both (trade an iron condor), the only cash you need is the maximum possible loss, reduced by the cash collected.

If you sell a 10-point spread and collect $300, your maximum loss is $700 – and that $700 (along with the $300 you collected) satisfies margin, and is available to cover losses if the worst possible result occurs.

299

2 Responses to Q and A. How Much Cash Needed to Sell Options?

  1. Great content Mark. Especially like the fact that you go over the “what if” scenarios.
    When you enter into a IC trade, do you ever initiate for two different expiration months simultaneously? Say one for May and one for June?
    Steve

  2. Mark Wolfinger 04/12/2009 at 11:11 PM #

    Steve,
    Thanks.
    Yes, I open different months simultaneously.
    Example, when May expires, and Sep become 4-month options, I intend to add both Aug (the new month) and Sep at the same time.
    When the Aprils go away, I’ll add Jul. I’ll also add Jun at that time – but only if I don’t already own enough June. I would not automatically add to Jun positions.