Because stock and futures options investments are often highly volatile, trading options on margin can be very risky for investors. It is important to understand options, margining and day-trading activities before getting involved in this fast-paced market. Learning about the option margin requirements set by financial regulators is essential for anyone who engages in frequent or substantial margin trading.
Basics of Margining
Trading on margin is the practice of using borrowed funds -- usually from a brokerage or a bank associated with them -- to purchase securities, options, bonds or other financial instruments. Traders often use margins as leverage to increase the effect of a trade, though restrictions do apply. In addition, traders may use a margin position to re-enter the market after closing a prior position. This is because funds from their previous position are technically unavailable until the position is "settled," or legally resolved. Trading on margin usually allows traders to open a new position, with the expectation that they will reimburse the brokerage when settlement takes place.
Margin Trading in the Options Market
Many stock and commodity options traders use margin calls as a part of their business practice. The Chicago Board Options Exchange and federal regulators set the requirements for margin trading in the options market, and the specific regulatory restrictions vary according to the type of instrument being traded and the trader's qualifications. Day traders are also subject to minimum equity requirements that are intended to help protect the integrity of the financial system.
Requirements for Day Traders
Pattern day traders are among the most extensive margin customers in the options market. According to the Financial Industry Regulatory Authority (FINRA), the definition of a pattern day trader "includes any margin customer that day trades (buys then sells or sells short then buys the same security on the same day) four or more times in five business days, provided the number of day trades are more than six percent of the customer's total trading activity for that same five-day period." FINRA rules require account holders to maintain at least $25,000 of minimum equity in their account for each trading day. Failure to meet this requirement for more than five days will result in a suspension of a day trader's margining capabilities for up to 90 days.
Options Margin Limitations
Some options may not be margined under CBOE rules. For example, long options with an expiration date of less than 9 months are not marginable, according to the CBOE. Long options -- options to buy or sell a given stock -- with an expiration of more than 9 months may be margined if the trader maintains at least 75% of the option cost themselves, and margins the rest. Those who offer others options -- or promise to buy stock from or sell stock -- must maintain collateral for up to 20% of the underlying interest, or the market position that they're optioning to another trader. According to the CBOE, the requirements for options writers are complex and often change with market conditions.
- Financial Industry Regulatory Authority: Understanding Margin Accounts, Why Brokers Do What They Do
- Chicago Board Options Exchange; New Portfolio Margining Rules; December 2006
- Chicago Board Options Exchange; Margin Manual; 2000
- Financial Industry Regulatory Authority: Day Trading Margin Requirements: Know the Rules
- Financial Industry Regulatory Authority; Investing with Borrowed Funds: No "Margin" for Error; November 2010
- Chicago Board Options Exchange: Overview of Margin Requirements for Options
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