Newbie question on margin related to credit spread selling

R

RobSwe

Good evening gurus,

I have a question on margin which is hopefully best related to the risk management sub-forum.

I did a personal self-evaluation a couple of weeks ago and found that selling OTM credit spreads on large liquid indices suits my own personality and style when it comes to balancing risk appetite/acceptance with personally acceptable returns.

EDIT: OTM here is one standard deviation or more away from the live price.

I have been working on a trade plan/system for roughly two weeks trying my best to turn over all stones. The major obstacle at this point in time for me is understanding how margin really works.

I use a T-Reg account with Interactive Brokers. The margin requirements themselves seem straight-forward enough:

Call spread:
Init margin: Maximum (Strike Long Call - Strike Short Call, 0)
Maintenance margin = Init margin.

Put spread:
Init margin: Maximum (Short Put Strike - Long Put Strike, 0)
Maintenance margin = Init margin.

What I struggle with to wrap my head around though is how much margin with respect to my account size is reasonable (I know, reasonable is subjective) to utilize.

Doing the typical youtube/google search plus following an introduction video on margin from Interactive Brokers unfortunately didn't really help explain how it works as often a lot of previous knowledge is assumed and of limited understandability for a newbie of the concept of margin.

Let's assume my account is around $25.000 and I wish to utilize the maximum margin with the minimum potential for a margin call/forced selling of securities.

It hasn't "clicked in my brain" yet of how the dynamics work here.

What would the implications be if I:
1. Settle at utilizing a margin amount of 50% of my account size ?
2. How about $20.000 in margin out of the available $25.000 ?
3. Hey, why not go "all out" and utilize the full $25.000 ?

Maybe you can help me in understanding the effects of this and/or how to think of margin on a higher conceptual level ?

Happy trading !

/Robert
 
Last edited:
Can your quest be simplified to Max Risk, which is constant for a static position, rather than Max Margin which may be dynamic? For your credit spreads, your Max Risk is Strike separation * size minus credit received. This remains constant until as long as your position is unchanged. Max margin is typically lower value, but may not be your real max risk. (My input may only be interesting to you if you are conservative; if you like to buy things you can't afford to pay for, then ignore my comments)
 
Hi step and thank you.

I consider myself as fairly conservative which comes from being burnt earlier which triggered me to study a number of courses from recognized successful traders focusing on consistency. I should have added that I aim for consistency with a balance (low variance) in equity swings.

So it is more useful to primarily focus on the question "What is my max risk/loss for the position ?" rather than how margin requirements change dynamically during the life of the trade ? If so, that would certainly make it easier in the monitoring/maintenance of a live position.

I still would like to understand though if I should consider setting a cap on the margin to available equity ratio or if this in practise is a non-issue ?

EDIT: I thought through your response a couple of times and realized that maybe I have misunderstood something basic here. Margin is basically another form of leverage but in the form of a loan, and I can without concern use up to my actual equity as it basically is a form of "indirect loan" from the broker. If I'm correct with this, this is probably why another concept called buying power exists which I think means "How much I can at maximum borrow from the broker".

Thanks step !

/Robert
 
Last edited:
For me personally, I enter and manage trades based on Max Risk, however I don't think most people do that! -- reading about LTCM biased my habits (leverage only what you can afford with cash to back it up) This does limit my return prospects, however!

I think different brokers compute margin differently for Reg-T accounts. Some may treat the puts and calls independently for Iron Condors, instead of a single position trade (may no longer be true). I have not bothered to investigate the Margin algorithms. Perhaps some others have.
 
Ok, "leverage only what you can afford to back up with cash". That makes good sense to me.
I think that made my brain click finally on how to view margin.

Understanding the actual algorithms used could of course be useful (I'm a bit of a math nerd so I probably will try and understand that just out of curiousity) but I personally agree with you that understanding the practical effects of how margin changes when testing with for example a paper account should suffice now that I got a grasp on the nature of margin.

EDIT: On Iron Condors I have noticed that Thinkorswim does limit the margin to the maximum risk, in effect the width is the risk as you mentioned above.
I haven't studied Interactive Brokers behaviour on Iron Condors as compared to a regular credit spreads but I will have a look at that.

EDIT2: I put your sentence "leverage only what you can afford to back up with cash" in my trade -and personal psychology draft plans now. I think it is quite brilliant in explaining margin in a short and succinct way.

Thank you kindly for helping me step ! :)
 
Last edited:
One caution with Interactive Brokers, the max margin you listed for a credit spread, while completely rational, is not what IB uses, because they're not. They actually use the current market price of the spread to determine your margin, even if it yields a loss greater than the max loss possible on the spread. Especially on OTM spreads which can be pretty illiquid with big and irrational bid/asks, it's not unusual to have IB auto liquidate you even though it was physically impossible for you to lose more than your margin.
The best solution to this is to stop using IB, they are a truely awful company and if you leave now you'll save yourself untold frustration at their willful stupidly. However while you're working on that, be sure you always put in a GTC order to buy one more contract than you want at just over the max intrinsic spread value, i.e. a offer to sell a 5 point spread for $5.05. It will most probably never be filled (and you'll always essentially break even if it is) and it ensures that IBs all knowing algorithm picks that up as your max loss (because it thinks there's someone out there willing to buy your spread for just over max intrinsic and is so stupid it doesn't know it's you) instead of some crazy number like $10 that pops up when the liquidity dries up.
 
I think Tom Sosnoff mentioned once about TOS that they use 20% of the strike as margin, but I am not sure if for spreads or just for one leg.
 
pompom said:
I think Tom Sosnoff mentioned once about TOS that they use 20% of the strike as margin, but I am not sure if for spreads or just for one leg.
More...
That would be crazy since your max loss on a spread is defined by the difference between the strikes. On a high priced security your margin would be super high, far above 5 points, for a 5 point spread while on a lower priced security it would be much lower, regardless of the fact that in both cases you can only lose a maximum of 5 points.
 
Sig said:
One caution with Interactive Brokers, the max margin you listed for a credit spread, while completely rational, is not what IB uses, because they're not. They actually use the current market price of the spread to determine your margin, even if it yields a loss greater than the max loss possible on the spread. Especially on OTM spreads which can be pretty illiquid with big and irrational bid/asks, it's not unusual to have IB auto liquidate you even though it was physically impossible for you to lose more than your margin.
The best solution to this is to stop using IB, they are a truely awful company and if you leave now you'll save yourself untold frustration at their willful stupidly. However while you're working on that, be sure you always put in a GTC order to buy one more contract than you want at just over the max intrinsic spread value, i.e. a offer to sell a 5 point spread for $5.05. It will most probably never be filled (and you'll always essentially break even if it is) and it ensures that IBs all knowing algorithm picks that up as your max loss (because it thinks there's someone out there willing to buy your spread for just over max intrinsic and is so stupid it doesn't know it's you) instead of some crazy number like $10 that pops up when the liquidity dries up.
More...

Thank you Sig. I was not aware of this. I intend to use SPX and NDX as underlyings. They are quite liquid even for OTM options. Still if a spread becomes wide the margin algorithm should of course never become higher than a maximum of the spread width.

I'll laborate with a paper account to study this. Currently I have a TD Ameritrade account too.

For the moment I use it mostly for the functionality in ToS and IB for trades as the commissions are slightly better at this point in time at IB.
Feel free to recommend another broker which honours common sense in margin.
 
I finished a draft of a trade plan for trading weekly credit spreads and attach it here as a simple text file. It's a work in prgress at the moment and I haven't studied all identified methods yet but it's a start. Feel free to comment and critique it. :)
 

Attachments

You must log in or register to reply here.
Back
Top