Understanding Margins in Options Trading

Margin in Options Trading

If you are buying options, no margin is required; you simply have to pay the premium (price). The total investment made by you when buying options is the premium times the lot size (Premium X Lot Size of the options contract).

While there is no margin requirement if you are buying options, you should know that, if you are selling options (in derivatives parlance, selling options is known as writing options), you will need to put a margin with your broker. When you are writing options, your maximum profit is the premium that you get by selling the option (if the option expires worthless at expiry), but your losses can be unlimited, if share price moves above or below the market price, depending on whether you are writing call or put options. You must be thinking, if profits are limited and losses are unlimited, why will anyone, want to write or sell options.

The reality is that, professional traders write (sell) options more than they buy options. The reason why professional traders like to write options more than buying them is outside the scope of our discussion, but retail investors should know that, writing options is very risky. Anyway, when you are writing options, you will make a profit if the premium decreases and you will make a loss if the premium increase.

You should know that, like futures prices, option premiums are marked to market. In a call option the premium increases when share price increases, premium decreases when share price decreases. In a put option the premium increases when share price decreases, premium decreases when share price increases. As a writer of the option, your profit or loss is the difference of premium at which you sold the option and premium at which you will square off. When you write (sell) an option, the premium amount (premium X lot size) is credit to your trading account (margin). The marked to market profits and losses are also credited / debited to your account on a daily basis.