I upgraded my IBKR account from cash account to margin account last year (2022) to trade vertical spreads options contracts (two-legged or more options contracts) but I have now found a better way to take advantage of this upgrade.
Essentially, having a margin account means you can borrow money from your brokerage. In return, you have to pay an interest back to your brokerage. A margin account is required for vertical spreads in the event one leg of the spreads get exercised early and you are forced to buy 100 shares of the underlying stock of the options contract (in a sell PUT contract), while the other leg of the contract (buy PUT) is still open. If there is not enough cash in your balance to pay for the 100 shares, you will then require to loan the remaining amount from your brokerage (go on margins) to buy the shares.
The risk of using margins is getting a margin call which gives your brokerage the right to liquidate (sell away) your shares to maintain your margin requirements. This means that you will lose the shares you do not wish to sell and possibly at a price that you are not comfortable to sell. I have shared more in this risk in this article:
Understanding The Risk Of Margins, Selling Naked CALL & PUTS
In this article, I wish to share another way to use the margin account, other than borrowing from your brokerage and going on margins. It is worth noting that having a margins account does not mean that you automatically go on margins. You only go on margins when you run out of cash in your account, i.e. when your balance drops to zero and you still need funding for your trades.
Selling Cash Secured PUT On Margin Account
I have realized that when selling a Cash-Secured PUT using a margin account, you do not need to have the collateral (total amount of cash) in your account to execute the trade, unlike a cash account.
Read more about how Cash-Secured PUT works in this article:
Why Are CALL and PUT Options Commonly Known As Covered CALL and Cash Secured PUT?
Take for example, you wish to sell a Cash-Secured PUT on Apple at a strike price of USD150, you need to have USD150 x 100 shares = USD15k of cash balance in your cash account in order to execute this trade. This is to prepare for the scenario if the contract gets exercised (either early assignment or when it expires In-The-Money), you have the funds to buy 100 Apple shares at your strike price of USD150.
However, with a margin account, you do not need to have that amount of cash in your account in order to execute the trade. This is because if the contract gets assigned (either early assignment by the option buyer or when it expires ITM), you will go on margins if you do not have enough funds. In short, a margin account doesn’t require you to have cash ready to buy 100 shares because your brokerage will lend you the money to buy the shares if the (sell PUT) contract gets exercised.
So, What’s The Strategy?
The strategy, in short, is to sell Cash-Secured PUT (CSP) on bullish stocks and not get assigned so as to earn more premium. In the event that the share prices drops instead of rises, and the options buyer decides to exercise the contract, I will have enough collateral/ funds parked elsewhere to be activated and thus, not required to go on margins.
I have explained the strategy further in this article:
How You Can Possibly Not Lose Money In Options Trading? | How To Trade Options Safely For Passive Income
It is basically selling an OTM CSP so as to give myself a safety net of a 20~30% share price drop before the underlying share price falls below the strike price and contract goes ITM. If this happens, I will roll it to a later date, to earn more time premium and to give the shares more time to recover.
My contingency plan is to activate the reserves that I have inside my SSB, so that I do not need to go into margins when the contract gets exercised:
Why I Am Building $120,000 Of Cash Reserves In Singapore Savings Bonds (SSB)?
However, there may be some lead time to redeem the bonds and free up my cash. In the meantime, I may need to go on margins for a short period. It is slightly comforting to know that Interactive Brokers (IBKR) charges the least margin rate as compared to other brokerages.
This contingency plan of using the amount in my SSB as a backup options allows me to sell PUT up to a total of S$120,000 worth of total share value. The good thing is that if the contract is not exercised, I continue to earn premium from my options contract as well as the interest from my Singapore bonds (not activated).
It is worth noting that this method should be used on stocks that are on an uptrend so there is a lower risk of the contract being assigned or exercised early. I hope you find this sharing useful and please do your due diligence and research when you dabble into using margins for your trades.
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