How do holds work when selling naked options?

Quote from JJacksET4:

Well, I'm not going to argue anymore, but understand - there is no margin here - my brother doesn't have a margin account. There is no formula - the formula you see is for margin accounts.

They cannot force a non-margin account to use margin. They (the broker) know a 20 put can never be worth more then $2000 and therefore, holding that cash in the account is enough. They cannot force money to be added to a non-margin account.

Let me just say this - On a non-margin account, they cannot and will not require more money be added for a put sale that was done.

JJacksET4
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the question was about cash-secured (therefore in a margin account). Now that you raised the nature of account, I have this question for you: would you give a loan to someone for zero interest rate?

Your brother is doing it, and if you are your own brother then you are doing it as well.
 
I have some comments, which I will post in form of questions to stimulate thinking. The first comment relates to cash secured puts. If vol goes up (even if market does not move), then the short put would require more than the cash for the given strike. Therefore, selling a put is never cash secured between the beginning of the trade and its end, even if it is secured at the end...

Short the put is also short volatility. If you have closed out by your brokers, it may happend when bid ask spreads are wide (very wide).
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Riskfree,

I think that you're getting lost in theoretical possibility versus practical reality with a touch of extenuating circumstance (g). Here's my take on your scenario...

In order for the put's value to approach the value of the strike, volatility must go up into the 1000's. That's not going to happen especially "even if market does not move". The other possibility is that the stock drops close to zero. In both cases, it will approach parity and will only trade above parity due to the spread.

Suppose the stock is 50 and you're selling a naked 50 put. Parity can be no more than 50. Now how wide will 1/2 the spread be? Will a $49 premium (stock at $1) go to 45-55? 40-60? Possible but very not likely, even in a crash. Long before a $50 stock hits $1, assignment will occur or we'll all be glowing.

And even if these wild/wide premiums did occur, my assumption is that it would not matter since the options price for margin calculation would be the average of the bid and ask which would at worst be parity (that's how my broker determines market price).

There is a theoretical situation where the short put would require more than the cash for the given strike but that assumes that you're going to be in the above situation where the stock loses most of its value and you're not assigned.

Consider a naked 50 strike put when the stock is $1. Assume that it's at parity or $49. Margin is 100% of option proceeds plus 20% of underlying's value. However, this position gets snagged by the minimum requirement which is the option proceeds plus 10% of the strike ($5400). Since the premium can be applied to the margin requirement, the margin call is $500.

Now if you sold this put when the stock was $50 , at $1, you didn't receive the $49 premium to offset. You have the premium received from the sale. Say 2 pts. Since the requirement is $5400, you're going to be $400 away from cash secured ($4800 + $200 premium) which is your premise. While this is theortetically possible, I think that in reality, it's just short of impossible.

To come full circle, your broker isn't going to sell you out if you have a cash secured $5,000 and $400 of margin.

As for your suggestion to "never sell the put, but rather implement it as a covered call", that's a whole nuther story because although the risk profiles are equivalent, the margin profiles are not.
 
Quote from riskfreetrading:

Mark:

I am not sure you correctly understand what I wrote,or that I am correctly understanding what you wrote, or that at least one of us is wrong although I think that what I wrote is correct and the core of what your wrote is not correct. Some points to clarify:

1. Selling the put or making a covered call (covered with stock) is the same thing (with some exception that we can skip for the moment) if held till the end.

So why are you saying that I am wrong in my what I wrote? It is basic put call parity.

I do not disagree with what you say about put/call parity.

But that's not what you said earlier. You stated that adopting CCW instead of selling NP would <b>eliminate the risk</b> that a huge spike in IV would result in being bought in by the broker.

I am saying you were incorrect when you posted the idea that writing the covered call instead of (its synthetic equivalent) the naked put will eliminate the problem of having your account partially liquidated. You will lose the same money, have the same margin call - and the broker will not be able to simply sell stock. They will buy in your very inflated calls. Still the same disaster.

I'm not arguing with your knowledge of options. It's merely your use of the term: 'cash-secured.'


2. To highlight my point on margin, let me give an example (a hypothetical one, but which will explain my point).

Suppose that when one sells a put, the vol is very low, so the put price is close to zero. Let us assume ATM.

Margin requirement at opening is 20% of price, plus proceeds from put (small).

Let us now assume that vol goes to the moon. Put price becomes equal to price of stock.

Margin requirement are now 20% of stock plus differential in price of put which is in total 120% of the ATM strike if stock does not move and vol goes to "infinity"

Conclusion: margin requirement of put can be higher than strike price/stock price (because ATM).

Therefore it is technically not cash secured in the sense that between the beginning and the end, one needs more than for margin than what is needed to buy the stock at the end (it is 20% more).

Do you now see my point a bit better?



I see your point better. I agree that margin requirement may be as high as you say it can be.

But that does not change the fact that you were talking about 'cash-secured' and not margin.

'Cash secured' is a phrase that has a specific meaning. You cannot choose to use the term in any manner that suits you. Regardless of any other factors, if you have <i>enough cash in your account to pay for any shares that you are obligated to purchase due to being assigned an exercise notice on puts you sold</i>, then you are cash secured.

You may still have a margin call. The margin requirement for the put may be more than the value of your account.

Your account may be in deficit.

Your broker may decide to liquidate your account (or part of it).

None of that matters when you speak of being 'cash secured.'

This is not a big deal. It's merely terminology.
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Quote from JJacksET4:

Woah! How can a 20 strike put be worth more then $2000? Other then maybe by a $10 spread or something, it's not going to happen! IV can go to 1000 and it won't happen.

JJacksET4
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'Worth' more than $2000?

Worth?

What an option is worth has nothing to do with anything. Not in a panic

It did happen.

I agree that it will not happen again. but it did happen.

In Octobe4 1987, there was a stock priced near $20. The bid/ask spreads were unbelievable. (That was true in every option around the trading floor.)

The market in this specific put was $15 bid - $25 asked. An outrageous market? Yes it was. But no one came into the pit to sell the puts at $15.

A customer who was being liquidated and who was forced to pay any price just to get out of the position, would have been forced to pay more than $20 for his 20-strike put.

I don't recall if the trade took place or not. But the asking price was above its 'maximum possible value' and anyone who entered a market order would have paid $25.

It was nuts on the floor. No one wanted to make markets. No one wanted to take the risk. Very sad, but don't believe that a put would never trade at a price higher than the strike.

It can and it has happened. The markets are more sophisticated and more electronic today, so this is not likely to happen. But never say never.

Mark
 
Quote from riskfreetrading:

That is why your brother should implement it as a covered call (sell call at the same strike as where to sell put).
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Again, the covered call will NOT help.

If the stock goes to $5 and the put asking price is $15, then the call price will be $10. yes, $10 for that FOTM call.

You may not believe this to be true, but it is.

If the call were any cheaper, the arbitrageurs would come in to collect free money. They would drive the call price higher, or the put price lower, locking in risks-free profits.

I don't want to take the space here, but before you keep repeating this story about CCW being better than NP, please learn about 'reverse conversions.'

Mark
 
Quote from JJacksET4:


Let me just say this - On a non-margin account, they cannot and will not require more money be added for a put sale that was done.

JJacksET4
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True. No more cash required once the put is cash secured.

But, the account can still go into deficit.

They may not issue a 'margin call' (because it's not a margin account) but the broker will not allow the account to remain in deficit.

If for some reason, the stock is marked at $4 and if the put is marked above $16, then the account will be worth less than zero. (Assuming the entire account consists of this one naked put plus cash.)

Unfair? Yes. Unreasonable? Yes. Impossible? No.

Mark
 
Quote from dagnyt:

Again, the covered call will NOT help.

If the stock goes to $5 and the put asking price is $15, then the call price will be $10. yes, $10 for that FOTM call.

You may not believe this to be true, but it is.

If the call were any cheaper, the arbitrageurs would come in to collect free money. They would drive the call price higher, or the put price lower, locking in risks-free profits.

I don't want to take the space here, but before you keep repeating this story about CCW being better than NP, please learn about 'reverse conversions.'

Mark
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The points you have been laboring on are not the point that I have been raising. I am starting to doubt the extent of your expertise, and/or the intent of your posts.
 
Quote from spindr0:

Riskfree,

I think that you're getting lost in theoretical possibility versus practical reality with a touch of extenuating circumstance (g). Here's my take on your scenario...

In order for the put's value to approach the value of the strike, volatility must go up into the 1000's. That's not going to happen especially "even if market does not move". The other possibility is that the stock drops close to zero. In both cases, it will approach parity and will only trade above parity due to the spread.

Suppose the stock is 50 and you're selling a naked 50 put. Parity can be no more than 50. Now how wide will 1/2 the spread be? Will a $49 premium (stock at $1) go to 45-55? 40-60? Possible but very not likely, even in a crash. Long before a $50 stock hits $1, assignment will occur or we'll all be glowing.

And even if these wild/wide premiums did occur, my assumption is that it would not matter since the options price for margin calculation would be the average of the bid and ask which would at worst be parity (that's how my broker determines market price).

There is a theoretical situation where the short put would require more than the cash for the given strike but that assumes that you're going to be in the above situation where the stock loses most of its value and you're not assigned.

Consider a naked 50 strike put when the stock is $1. Assume that it's at parity or $49. Margin is 100% of option proceeds plus 20% of underlying's value. However, this position gets snagged by the minimum requirement which is the option proceeds plus 10% of the strike ($5400). Since the premium can be applied to the margin requirement, the margin call is $500.

Now if you sold this put when the stock was $50 , at $1, you didn't receive the $49 premium to offset. You have the premium received from the sale. Say 2 pts. Since the requirement is $5400, you're going to be $400 away from cash secured ($4800 + $200 premium) which is your premise. While this is theortetically possible, I think that in reality, it's just short of impossible.

To come full circle, your broker isn't going to sell you out if you have a cash secured $5,000 and $400 of margin.

As for your suggestion to "never sell the put, but rather implement it as a covered call", that's a whole nuther story because although the risk profiles are equivalent, the margin profiles are not.
More...

Did you know about the margin theoretical point I raised before reading my posts here? If yes when did you know about it, under what circumstances, why, etc?

The point I raised was just a start to show other things. You seem to understand that covered calls and puts are not the same position from a margin point of view. The general result is that they are the same in loss and gains at the end, but there are not the same DURING the life of the positions in terms of other things.

I wanted to get people to think, as I stated in my first post on this thread. I may have explicitely stated that I will comment in form of questions to provoke peoples' thinking.

Maybe I should simply stop sharing.
 
Quote from riskfreetrading:

The points you have been laboring on are not the point that I have been raising. I am starting to doubt the extent of your expertise, and/or the intent of your posts.
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My intent is to not allow you to spread erroneous information among people who come to this board seeking help.

The simple truth is that writing a covered call will not prevent the margin calls or buy-ins that you foresee for naked put sellers.

That may or may not be the main point of your posts, but you have said it more than once and it is simply not true.

Mark
 
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