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Friday Q&A

Friday Q&A Hello Smart Option Sellers! Seems the new GIS put-sell trade from earlier today is being filled with no problems. I've been getting email confirmations from many of you and will have the official results on Monday. Let's get to the questions. Q: Analysing profit includes commissions buying and selling don't they? Letting them mature reduces one commission. A: We need to take commissions into acccount when figuring out our net profit/loss. Commissions are a cost of doing business and need to be added into the bottomline. Since I don't know what everyone pays, and I'm sure they're different, I don't include commissions in our final numbers. And yes, if we let the trades expire worthless, we could get away with not paying that extra commission. Although, at some brokers, if you buy an option back for $.05 or less per contract, they will charge zero commissions. Ask them! Q: Lee, I received a letter from Schwab stating due to market volatility, they are changing their margin requirement to 35% of naked puts held. This puts me in a negative cash balance situation, so I can add more equity, buy some puts to close, or perhaps take a spread on some of the holdings. As to the latter, do you see any opportunities in the current portfolio? A: They're just protecting themselves, which I can understand, but I'm sure the margin rates will come down again when the volatility subsides (which it will). For now, one of the classic ways to get around large margin requirements is to buy another option contract and turn the original put-sell trade into a spread. But it's dependent on which strike you buy. In order to do this and keep most of your premium intact from the original put-sell, you'd want to look for a lower strike price put option and try to pay maybe $.05 or less for it. In the case of spreads, the most you could lose is the difference between the strikes minus the credit received. Most brokers would use that maximum loss as the margin requirement. For instance, if we sold a $40 put option for $.30 per contract and bought the $20 put option for $.05, the spread would be $20 wide ($40 - $20 = $20) with a net credit of $.25. The most you could lose on this trade would be $2,000 minus the $25 credit = $1,975. This would cut down your potential maximum risk in the trade of selling the naked $40 put on its own. Your downside risk on the $40 put would be $4,000 minus the credit of $30 = $3,970. The margin requirement on selling the naked $40 put by itself is typically 20% of the full cost of buying the stock. In this case it would be (20% x $4,000 = $800). $800 would be the margin requirement. That's a lot less than the spread's margin requirement of $1,975. Clearly, even though the spread cuts down on your total potential risk, selling the naked put in this case would have a smaller margin requirement. Seems odd, doesn't it? Before I hold myself to being 100% accurate on these calculations, I think I'll check with Charles Schwab and see what they say. Maybe the broker would use 20% of the $2,000 of risk as the margin for the spread. That would equal $400, and clearly less than the $40 put's margin requirement. Let me inquire into that and I'll give an update at a later time. On another note, if you used a $5 wide spread (let's say the $40 and $35 strikes), the spread would have a smaller margin requirement ($500) versus the $800 for the naked $40 put-sell. So it's very dependent on how wide the strikes are apart. I know this is getting quite technical, but it's good to know about the subject. Lastly, as you mentioned in your question, you can always close some other positions to help alleviate the margin. Instead of buying an option back at $.05 per contract, you may have to buy it back at $.10 per contract. Less profit, but freed up margin. Always a trade-off! Q: Hi Lee. Is what we are primarily doing also referred to as short puts? There was an email update I received yesterday from tastytrade where they had a 7-minute segment referring to changes that could happen to your capital requirements when the market makes a sudden adverse move. ( Is this referring to change of capital requirements during use of margin and, as I am primarily doing these trades in a non-margin IRA account, this would not have the same effect when margin is not used? That is, I have to have cash available to cover the entire position. A: Yes, we are shorting puts. Selling = shorting, in trader lingo. Now, as seen in the last question, a broker can jack up the margin requirements during times of turbulence. Not only that, but as stocks drop, and it looks like the chances of the stock moving closer to the strike price sets in, the margin will automatically go up. This is to protect the broker from having to foot the bill if you can't cover the potential full purchase price of the stock if called upon to do so. But, when stocks go back up and volatility falls, the margin requirements will drop again. They ebb and flow just like stock prices. In the case of selling puts in a cash account or IRA, none of this matters, as you will always need to have the cash on hand at all times to cover the full cost of buying the stock. Q: good morning lee on the vxx vertical is the margin 20% of the difference ie the risk? A: Funny you ask as we just discussed this in the question above. Considering the VXX spread is only $1 wide ($45 & $46 calls), the margin requirement would be $100 minus the credit of $30, So the margin requirement to sell one of these trades would be $70 per position. That also happens to be the most you could lose per spread. As far as it being 20% of the $70 ($14), I will check with Schwab for confirmation. If you happen to be a Schwab client, here's the page on margin requirements. Q: Currently, your portfolio has 13 puts and 1 straddle. How much equity is needed to support these holdings and at what margin ratio is your firm requiring? A: This is broker-dependent, and also dependent on how many of the positions you actually have. We all know that when selling options, you will have a margin requirement. So, if you have a stake in all 14 of our trades, your broker will set the tone (typically 20% of the cost to buy all the stocks), on how much you'll need to keep in the account. Any specific questions like this should be directed towards your broker. That's all for today. Have a great weekend! Continue to contact me here Regards,

Lee Let's Grab That Cash!


Current Portfolio Continue to work all other trades as instructed and continue to hold all other open positions as-is. See the Current Portfolio below for current prices & instructions. Note on the Current Portfolio - if you are a new subscriber and don't have a position yet on any of our trades, make sure you enter your order at the original recommended sell prices. Do no enter any order unless the current option price is at, or higher, than the official recommendation. If you are unsure or have any questions, please ask us!

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