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Understanding Options Trading Margin Requirements For Naked Options

February 10, 2020

Get ready traders – in this blog we are going to look at understanding the trading margin requirements for naked options trading and option selling.

If you plan to sell options as part of your overall trading strategy, you need to understand how margin requirements work. In this blog, we will look in detail at what your broker will require for you to execute these types of trades.

Our Trading System Is Based On Selling Options

I base my trade strategies in option selling. This doesn’t mean we only sell options; we trade iron condors and credit spreads as well. But each of these strategies allows us to collect option premiums up front and put up margin for the trade.

We know just how frustrating it can be to buy a call or put on a stock that moves against you and loses you money. Much of the time, you are paying for time decay which is slowly eating away at your profits each day. As a result, the stock moves and yet the option expires with little or no value at expiration.

Understanding Margin Requirements

Just like trading commissions, brokers can have very different margin requirements. However, they must all adhere to the minimum required by the Financial Industry Regulatory Authority (FINRA) and the option exchanges where the contract is traded.

For example, Charles Schwab’s margin requirements are much higher than the industry standard, while thinkorswim offers lower Portfolio Margin for higher account values.

At any rate, you should check the specific requirements of your broker to know which margin standards they will apply to your particular type of trading account.

Broker Clearance Levels For Options Trading

When you open your account with a broker, you should request options trading authorization. Some brokers will classify options trading clearance within different levels ranging from one to four.

Usually, to buy options you need the basic level or level one clearance. If you plan on selling naked puts (not calls) you more than likely need level two clearance. But the margin is much higher as you are still seen as a beginner trader by the broker. If you have the necessary experience, I highly recommend you try to obtain level three or higher approval as the margin requirements will be much lower and you will be able to buy and sell options at any time.

Sample Broker Margin Schedule

Below is a quick sample margin schedule from our broker thinkorswim. Margin schedules are great to help you quickly calculate and determine if you are going to have enough buying power for a particular position or strategy. (Click to enlarge).

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How Do Brokers Calculate Margin?

We are going to assume for now that you have level three clearance which has slightly lower margin requirements than lower levels. For those of you who are math wizards, you are going to love this stuff. Everyone else, you are just going to have to take us at our word on these calculations.

Here’s the basic calculation:

(25% of the underlying stock’s market value + the option ask price – any out-of-the money amount) x 100 (per contract) x the number of contracts

The value of the above equation must be greater than:

* (The option ask price + 10% of the stock’s current trading price) x 100 (per contract) x the number of contracts, or

* The number of contracts x $500 per contract.

If either of these two calculations yield a higher margin amount, then the highest value is used.

We want to point out at this point that having margin clearance within your broker does not mean you will be forced into a “margin call” should your trade go bad. If you have enough cash or stock holdings within your account to cover the margin requirements, then a trade will not trigger the activation of the margin (borrowing capacity) that is available to you.

Ways To Reduce Your Margin

There are some strategies you can take to reduce your margin and we have created a short video looking at a couple of ways we can reduce our margin requirements on trades.

This is an excellent video, not only for people who have larger accounts but if you’re trading an IRA account and you want to mimic some of the undefined risk traits that we do here. Or that anybody does, basically your straddles and strangles and ratio spreads, it’s going to be hard to do that because those trades usually require a lot of cash up front for your IRA or your retirement account.

We look at some simple ways that you can reduce or cut your margin requirements and also increase your return. Again, with larger accounts, you’ll want to trade slightly more undefined risk trades. These give us the biggest PNL, dollar-wise, at the end of the year, but, of course, they tie up a lot of capital margin.

In the video, we talk about reducing those market exposures on selected strategies. This helps not only reduce overall risk in the portfolio, but also increases return on capital which can dramatically help with our overall profit, and use of funds.

We also have a second video which shows you how to free up more margin and cash to help you continue trading regularly.

If you have any other questions about understanding margin requirements for options trading, please feel free to add the into the comment box below, and we will answer them for you.

What You Need to Know About Options Trading

With the rise of the internet came many online money making opportunities. Financial brokers set up online platforms that made it easy for traders to invest in different financial instruments.

Traders could now easily buy and sell forex, CFDs, indices and commodities among other assets from the comfort of their homes or offices. Then, brokers introduced options.

This new form of financial instrument was adopted fast by traders all over the world. However, some financial authorities banned options brokers from operating within their jurisdictions.

Why?

Many claimed that it’s a form of gambling.

But is this really true?

Is iq option gambling?

This guide will discuss what options trading is all about.

Overview of options

Options are a type of derivative security. That means that their value is linked to the value of the underlying asset. Therefore, as an options trader, you’re not buying or claiming ownership of the underlying asset. Rather, you’re speculating on whether the asset’s price will rise or fall over a fixed period of time.

When trading options on the IQ Option platform, your primary objective is determining whether the price of the underlying asset will rise or fall within a certain time.

Let’s take a look at how this works.

Trading options on IQ Option

Start by clicking on the plus (+) button at the top of your IQ options trading account and select options. Choose your preferred asset. In this example, I’m using the EUR/USD currency pair. I’m also using 5 minute interval candles.

Next, select the trade expiry time.

Next, enter the amount to trade.

Finally, based on your analysis, select either higher or lower.

Is options trading a form of gambling?

Like gambling, options trading can make you money or not.

Many people argue that options trading is similar to gambling. All you need is luck to make a winning trade. But options trading is much more than deciding whether to press the higher or lower button.

As an options trader, you’ll still need to apply the skills used by other traders participating in other financial markets. You’ll need to be adept at technical analysis as well as reading the price charts. Proper money management and emotional control are also essential to become a successful options trader.

Others will argue that options trading is prone to broker manipulations. That is, the broker works behind the scenes changing prices at will to their advantage. This is highly unlikely because the price charts used by options traders are the same charts used by traders investing in other financial instruments.

Options trading unmasked

When trading other financial instruments such as fx or stocks, you can only buy an asset if there’s someone on the other side selling. Conversely, you can only sell an asset if there’s someone on the other side buying.

Options are a bit different. You are essentially speculating on whether the price of an asset will rise or fall over a specified period of time. So if you buy an option, the seller is essentially your broker – not another trader. The broker therefore has the right to set the return on your winning trades. This ensures that the broker still makes money even if your trades are winners.

As such, brokers will rarely manipulate prices to ensure that all traders have losing trades.

Many new options traders think that this is a quick way to make money. However, just like trading in other markets, options traders need to equip themselves with knowledge. They must acquire price chart reading skills as well as proper money management and emotional control. Without this, options trading simply becomes a form of gambling.

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The Options & Futures Guide

Learn option trading and you can profit from any market condition. Understand how to trade the options market using the wide range of option strategies.

Discover new trading opportunities and the various ways of diversifying your investment portfolio with commodity and financial futures.

To help you along in your path towards understanding the complex world of financial derivatives, we offer a comprehensive futures and options trading education resource that includes detailed tutorials, tips and advice right here at The Options Guide.

Profit graphs are visual representations of the possible outcomes of options strategies. Profit or loss are graphed on the vertical axis while the underlying stock price on expiration date is graphed on the horizontal axis.

Option Basics:
What are Stock Options?

Before you begin trading options, you should know what exactly is a stock option and understand the two basic types of option contracts – puts and calls. Learn how they work and how to trade them for profits. [Read more. ]

Binary Option Basics:
What are Binary Options and How to Trade Them

Binary option trading is quickly gaining popularity since their introduction in 2008. Check out our complete guide to trading binary options. [Read more. ]

Beginner Strategy:
Covered Calls

The covered call is a popular option trading strategy that enables a stockholder to earn additional income by selling calls against a holding of his stock. [Read more. ]

Stock Option Advice:
Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read more. ]

Stock Option Trading Basics:
Why Invest with Options?

For the short to medium term investor, stock option investing provide an additional suite of investment options to let him make better use of his investment capital. [Read more. ]

Advanced Concepts:
Understanding Option Greeks

When trading options, you will come across the use of certain greek alphabets such as delta or gamma when describing risks associated with various options positions. They are known as “the greeks”. [Read more. ]

Option Trading Advice:
How a Low Commission Broker Can Increase Option Spreads Profits by 50% or more

Many options traders tend to overlook the effects of commission charges on their overall profit or loss. It’s easy to forget about the lowly $15 commission fee when every profitable trade nets you $500 or more. Heck, it’s only 3% right. [Read more. ]

Stock Options Advice:
Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read more. ]

Advanced Concepts:
Put Call Ratio – What It Is and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read more. ]

Advanced Concepts:
Futures Options Trading

Another way to play the futures market is via options on futures. Using options to trade futures offer additional leverage and open up more trading opportunities for the seasoned trader. [Read more. ]

Stock Option Advice:
Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read more. ]

Stock Options Tutorial:
Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read more. ]

Stock Options Advice:
Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read more. ]

Stock Option Tutorial:
Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read more. ]

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