Options are complex financial instruments that enable you to speculate on the future price movements of assets. One of the most popular ways to generate returns from options trading is by selling options contracts, also known as options writing.
The strategy involves selling options contracts to earn a premium upfront and banking on the decline of the option premium due to the passage of time, also known as time decay. However, to sell options, you need to deposit a margin. In the context of derivatives trading, margin refers to the amount you need to deposit with your stockbroker to initiate a position. The deposited amount is used to cover potential losses due to adverse market movements.
That said, how do you determine the amount of margin required to write a particular option contract? Here is where an option selling margin calculator can help. It is a unique tool designed to help you estimate the margin requirements for selling an option contract. In this article, we are going to understand why a margin is levied when writing options, what an options-selling margin calculator is and how you can use the tool to plan your trades.
Understanding Options Selling
To purchase an options contract, be it a call or a put option, you must pay a premium to the contract seller. Buying an option gives you the right, but not the obligation, to purchase or sell the underlying asset on the contract expiration date.
If the market moves against your expectations, you may simply choose not to exercise the option you purchased on the contract expiration date. However, doing so will cause you to lose the entire premium paid to the seller. This, incidentally, is the maximum loss you can suffer when buying options.
On the other hand, when you sell an option contract, you are obligated to purchase or sell the underlying asset on the contract expiration date. Even if the market moves against you, you must fulfil your end of the contract. The maximum loss, in this case, is theoretically unlimited. Here is an example to help you understand the concept better.
Assume you sell a call option contract of a particular stock with a strike price of Rs. 2,100. The premium is Rs. 100 and the lot size is 500 shares. Since you are the seller of the contract here, you will receive a premium of Rs. 50,000 (500 shares x Rs. 100).
Say that the stock is currently trading at Rs. 2,000. Your options position will make money only if the stock price falls. If it rises, however, you will make a loss. Since there is no limit to how much the stock price can rise, the loss is theoretically unlimited.
Why are Margins Levied on Options Selling?
As you have seen, with option writing, the risk is unlimited if the market moves adversely. Since there is no limit to the amount of money you can lose when selling options, exchanges collect a margin upfront. This ensures that you have sufficient funds to cover the potential losses that may occur.
If the losses from option writing exceed the margin you initially deposited, the exchanges will raise a margin call asking you to deposit additional funds. Failing to meet the margin call within the stipulated time will lead to the exchanges automatically squaring off your open short positions to prevent further losses. Additionally, you will be temporarily suspended from trading and be asked to pay a penalty for the shortfall.
What is an Option Selling Margin Calculator?
An option selling margin calculator is a tool that enables you to determine the margin requirements for selling an options contract. The calculator takes different factors into account, such as the trading segment, underlying asset, type of option, strike price, quantity, contract expiration date and prevailing market conditions.
By entering the above parameters into the calculator, you can quickly obtain accurate margin requirements before entering a position. With the tool, you can plan your options trading strategies better and make informed decisions.
How to Use an Option Selling Margin Calculator
Using an option selling margin calculator is relatively straightforward. Here is a general overview of the process you need to follow.
- Step 1: Choose an option selling margin calculator of your choice.
- Step 2: Select the segment you wish to trade in. You will find multiple segments listed here, namely, NFO, BFO, MCX, NCDEX and CDS.
- Step 3: Select ‘Options’ as the product type.
- Step 4: Choose the asset from the drop-down list. Alternatively, you can also enter the name of the asset in the search bar to make it easier to find the contract you are looking for.
- Step 5: Select the option contract expiration date from the drop-down list. You will usually find three contracts: near-month, next month and far-month contracts.
- Step 6: Specify the strike price of the options contract you wish to sell.
- Step 7: Enter the quantity of the asset you wish to sell. The quantity must be in multiples of the minimum lot size applicable for the contract.
- Step 8: Select the type of option - call or put.
- Step 9: Click on the ‘Add’ button.
The option selling margin calculator will immediately display both the SPAN margin as well as the exposure margin you need to deposit to initiate a short position in the contract of your choice.
The SPAN (Standard Portfolio Analysis of Risk) margin is the minimum amount of margin required to initiate a derivatives position, whereas the exposure margin is an additional margin component that stock exchanges charge over the SPAN margin to cover Mark-To-Market (MTM) losses and other risks.
Plan Your Options Trades Better with the Samco SPAN Margin Calculator
If you are a trader who writes options, knowing the exact amount of margin you need to deposit before you initiate the position is crucial. It will enable you to understand your risks better and plan your strategies more effectively.
Available on the Samco trading platform, the Samco SPAN margin calculator is one of the most reliable option selling margin calculators. It has a simple and easy-to-use interface with support for stock options, index options and currency options contracts available on the National Stock Exchange (NSE).
The calculator uses real-time asset prices and volatility levels, to ensure accurate margin calculations. One of the major features of the Samco SPAN margin calculator is the flexibility to adjust the input parameters according to your preferences and risk tolerance.
Whether you want to explore different strike prices, contract quantities or expiration dates, the calculator can accommodate all of your requirements. You can even add the same contract with different strike prices and quantities to compare the margin requirements and plan your trades accordingly.
So, what are you waiting for? Open a Samco demat account today and get access to the SPAN margin calculator and a host of other useful tools. What’s more, the Samco trading app also offers multiple options-focused features, such as advanced charting tools and a comprehensive multi-leg options strategy builder.
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