Whether I am selling call or put options I prefer to use a cash account. That’s where we invest and utilize only our own cash to purchase stock and secure put trades. More aggressive investors may want to magnify their returns by leveraging margin accounts. This entails borrowing money from the broker based on rules and regulations set forth by both FINRA (Financial Industry Regulatory Authority) and the specific brokerage. Using this leverage can magnify both gains and losses. In this article, we will compare the differences between selling puts in a cash account (cash-secured) and in a margin account.
Put-selling in a cash account
When we sell a cash-secured put we are obligated to buy the stock at the strike price if exercised. If stock XYZ is trading at $44.00 and we sell the out-of-the-money $40.00 put for $0.50, we must set aside $4000.00 in our cash account to be available to purchase the shares. Since we are allowed to apply the put premium ($50.00 per contract) to the required amount, our total cash investment is $3950.00 as shown in the screenshot below:
If we sold 10 contracts, the required cash to secure the trade would be $39,500.00.
Put-selling in a margin account
Different brokers may have slightly different margin requirements so consider these general formulas and check with your specific broker regarding your margin account obligations. The amount of margin required is the greater of:
1- 25% of the underlying stock price – the out of the money amount (if there is any) + option premium x number of contracts x 100. In the example shown for the cash account the formula in a margin account is:
[(.25 x $44.00) – $4.00 + $0.50] x 10 x 100 = $7500.00 OR
2- 15% of the strike price + option premium x number of contracts x 100. The formula in scenario #2 is:
[.15 x $40.00) + $0.50] x 10 x 100 = $6500.00
Since the greater of these two equations calculates to $7500.00, this is our initial margin requirement.
Other factors to consider in margin accounts
Maintenance margin during the life of the contract, margin call and interest that must be paid for borrowing from our brokers are factors that must be managed and considered when using margin accounts. We must always check with our brokers to fully understand our trading obligations and costs.
Put-selling in margin accounts offers the potential to magnify gains by borrowing from our brokers. There is also higher risk since losses can also be elevated. Each broker will offer formulas which determine the amount of margin we are required to provide initially and for maintenance and these formulas will vary from broker-to-broker but must also meet FINRA and SEC regulations.
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Global flat for the week. Rising US crude oil inventories sent prices down this week. West Texas Intermediate crude fell to $49.25 per barrel from $53 a week ago, while global Brent crude slumped to $52.10 from $55.50. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), was little changed (11.66). This week’s reports and international news of importance:
- Nonfarm payrolls rose 235,000 in February, more than economists anticipated. The strong data, along with upward revisions to prior months, have prompted Fed watchers to begin to forecast a faster pace of tightening by the US Federal Reserve.
- The unemployment rate dipped to 4.7%, while the labor participation rate rose to 63%
- European Central Bank president Mario Draghi said this week that deflation risks in the eurozone have “largely disappeared,” as ECB inflation forecasts were raised to 1.7% from 1.3% for 2017 and 1.6% from 1.5% in 2018
- At its annual meeting of the National People’s Congress, China announced it had reduced its official economic growth target to 6.5% for 2017 from a range of 6.5%–7% in 2016. Actual growth in 2016 was 6.7%.
- Scottish first minister Nicola Sturgeon says late 2018 could be the best time for a second referendum on independence from the United Kingdom. Brexit has set off fresh calls for independence
- German factories started the year negatively as new orders fell 7.4% in January, the largest drop since the depths of the financial crisis in 2009
- The United States reported its largest monthly trade deficit in nearly five years this week. January’s deficit rose 9.6% from December, to $48.5 billion. US Commerce Secretary Wilbur Ross, calling for free and fair trade, said the latest data show that there is much work to be done on trade agreements
- South Korea’s president, Park Geun-hye, was forced from office as the country’s Constitutional Court unanimously upheld the National Assembly’s vote to impeach her after she became embroiled in a corruption scandal. Presidential elections must be held within 60 days, with acting president Hwang Kyo-ahn heading the government in the interim
THE WEEK AHEAD
MONDAY, March 13th
- None scheduled
TUESDAY, March 14th
- Producer price index Feb.
WEDNESDAY, March 15th
- Consumer price index Feb.
- Retail sales Feb.
- Home builders’ index
- Business inventories Jan.
- FOMC announcement
THURSDAY, March 16th
- Weekly jobless claims 3/11
- Housing starts Feb.
- Building permits Feb.
FRIDAY, March 17th
- Industrial production Feb.
- Consumer sentiment index March
- Leading economic indicators Feb.
For the week, the S&P 500 moved down by 0.43% for a year-to-date return of 5.98%.
IBD: Market in confirmed uptrend
GMI: 4/6- Buy signal since market close of November 10, 2016
BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes. A 25-basis point March interest rate hike appears already factored into market pricing.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a slightly bullish outlook. In the past six months, the S&P 500 was up 10% while the VIX (11.66) declined by 22%.
Wishing you the best in investing,
Alan (email@example.com) and the BCI team