Selling put options - interest paid

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jirikv80
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Selling put options - interest paid

Post by jirikv80 » Tue Jul 09, 2019 2:49 pm

Hi, assuming I have margin account and I sell 200$ strike price put option. Premium 0$. So the money I need to cover if exercised is 20 000$. I have 10 000$ cash and possible another 20 000$ from margin. Until the option is exercised do I have to pay any interest to the broker?

Thesaints
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Re: Selling put options - interest paid

Post by Thesaints » Tue Jul 09, 2019 3:28 pm

Why would you write an option for no premium ??

Anyway, you only pay interests on borrowed amounts, not on available margin amount.

jminv
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Re: Selling put options - interest paid

Post by jminv » Tue Jul 09, 2019 3:32 pm

jirikv80 wrote:
Tue Jul 09, 2019 2:49 pm
Hi, assuming I have margin account and I sell 200$ strike price put option. Premium 0$. So the money I need to cover if exercised is 20 000$. I have 10 000$ cash and possible another 20 000$ from margin. Until the option is not exercised do I have to pay any interest to the broker?
Why is the premium your receive $0 when you write the put? I am going to assume that's a typo since otherwise you're taking on risk for free. Depending on your broker, you can be paid interest on the 10k cash you have on hand. You won't pay interest on unused margin. You will have to meet your broker's margin requirements for selling naked puts.

Out of curiosity, what are you writing puts on and why?

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jirikv80
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Re: Selling put options - interest paid

Post by jirikv80 » Tue Jul 09, 2019 3:40 pm

Thank you Thesaints, the premium 0$ is misleading. It should have simplified the example. No reason to sell put option with no premium.

To be sure, with margin account, so for the time the option is sold but not exercised, no money is borrowed so no interest paid. Is that correct?

With NO margin account, which is my current situation. The amount $ for the option (strike * 100) is blocked since the beginning as cash. I am trying to validate, that margin account solves this and unless exercised it is "free". Any obvious drawbacks I do not see now?
I assume I am comfortable with the stock and strike price when exercised.

Topic Author
jirikv80
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Re: Selling put options - interest paid

Post by jirikv80 » Tue Jul 09, 2019 3:49 pm

jminv wrote:
Tue Jul 09, 2019 3:32 pm
Out of curiosity, what are you writing puts on and why?
Selling put options for value stocks or commodity ETFs USO, SLV that I would like to own for a better price, that is currently trading.
Kind of trying to understand the use of margin to be prepared for the future if stocks become cheaper that I could become possibly more aggressive and sell puts for strike prices I would be comfortable to buy even on margin.
Does it make sense to you?

ThrustVectoring
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Re: Selling put options - interest paid

Post by ThrustVectoring » Tue Jul 09, 2019 6:02 pm

When you sell an option, you immediately get the premium in cash and have an ongoing liability to fulfill the contract. The broker will ensure that your account maintains enough value in case they need to liquidate things in order to fulfill the liabilities you have.

This exchange of cash-for-assets has an implied interest rate attached to it, but that's not paid to your broker. It's paid to the person who bought the option, who has an arbitrage play (the "box spread") available to them that can convert these contracts to a guaranteed fixed payout at expiration.

From your perspective, selling options will do two things. It will give your account the option premium in cash terms, giving you either extra interest-bearing cash or reducing the interest charged on margin. It will also add a risky liability, which will reduce your total account value and increase the amount of account value your broker will require your account to have.

In concrete terms, in your situation your account would go from "$10k cash" to "a bit more than $10k cash plus an offsetting liability for the put option". Your broker will also require the cash minus the put option to have a value over some number, at which point your broker will use your cash to buy back the put option. When the contract executes, you'll exchange $20k of cash for 100 shares of the underlying security, regardless of the security price, at which point your account will be accruing interest on $10k of margin and have some amount of overall value based on the market price of the security.

Overall, this means that selling put options is a way to access leverage. You're still paying for it, but it's in the form of the contract being cheaper than it "should" be if interest rates were zero.
Current portfolio: 60% VTI / 40% VXUS

ralph124cf
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Re: Selling put options - interest paid

Post by ralph124cf » Tue Jul 09, 2019 7:42 pm

A put option is another way to enter an out of the money limit order. You decide that you would like to buy this stock, if it falls by a certain amount. Unlike a limit order, you collect a small premium for writing the order.

Ralph

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305pelusa
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Re: Selling put options - interest paid

Post by 305pelusa » Tue Jul 09, 2019 8:11 pm

jirikv80 wrote:
Tue Jul 09, 2019 3:40 pm
To be sure, with margin account, so for the time the option is sold but not exercised, no money is borrowed so no interest paid. Is that correct?
Correct.
jirikv80 wrote:
Tue Jul 09, 2019 3:40 pm
With NO margin account, which is my current situation. The amount $ for the option (strike * 100) is blocked since the beginning as cash. I am trying to validate, that margin account solves this and unless exercised it is "free". Any obvious drawbacks I do not see now?
I agree with you and I don't see a drawback either. If you're gonna sell puts, you might as well transform the account to a margin account if only for the simple reason that it decreases the margin requirements to sell them.

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whodidntante
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Re: Selling put options - interest paid

Post by whodidntante » Tue Jul 09, 2019 8:30 pm

ralph124cf wrote:
Tue Jul 09, 2019 7:42 pm
A put option is another way to enter an out of the money limit order. You decide that you would like to buy this stock, if it falls by a certain amount. Unlike a limit order, you collect a small premium for writing the order.

Ralph
I suggested writing a put option to someone who said they were waiting for an X% drop to get back in, with the money just sort of marking time in a MMF. I got the impression that I lived on another planet and the universal translator was broken.

Thesaints
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Re: Selling put options - interest paid

Post by Thesaints » Tue Jul 09, 2019 8:34 pm

ralph124cf wrote:
Tue Jul 09, 2019 7:42 pm
A put option is another way to enter an out of the money limit order. You decide that you would like to buy this stock, if it falls by a certain amount. Unlike a limit order, you collect a small premium for writing the order.

Ralph
They are quite different situations.

XYZ trades at $50

A enters a limit order at $45
B writes a Put strike 45 and cashes, let's say, $2

Bad news! XYZ business is flawed. SEC is on their tail and may impose heavy fines. Cost of whatever raw material they use spikes up.

XYZ now trades at 47 trending down

A simply cancels his order in the light of these news.
B instead is holding this hot potato he needs to get rid of. Too bad now the same Put trades at $3 and he loses $1 + the cost of two trades.

ThrustVectoring
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Re: Selling put options - interest paid

Post by ThrustVectoring » Tue Jul 09, 2019 8:47 pm

Thesaints wrote:
Tue Jul 09, 2019 8:34 pm
ralph124cf wrote:
Tue Jul 09, 2019 7:42 pm
A put option is another way to enter an out of the money limit order. You decide that you would like to buy this stock, if it falls by a certain amount. Unlike a limit order, you collect a small premium for writing the order.

Ralph
They are quite different situations.

XYZ trades at $50

A enters a limit order at $45
B writes a Put strike 45 and cashes, let's say, $2

Bad news! XYZ business is flawed. SEC is on their tail and may impose heavy fines. Cost of whatever raw material they use spikes up.

XYZ now trades at 47 trending down

A simply cancels his order in the light of these news.
B instead is holding this hot potato he needs to get rid of. Too bad now the same Put trades at $3 and he loses $1 + the cost of two trades.
Also, a limit order does not guarantee that you make the trade at the limit price. It could close at $47, release some bad news overnight, and open at $43, the price you buy it at. This is good for the limit order, but a significant problem when it comes to stop-loss orders.
Current portfolio: 60% VTI / 40% VXUS

Thesaints
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Re: Selling put options - interest paid

Post by Thesaints » Tue Jul 09, 2019 8:51 pm

jirikv80 wrote:
Tue Jul 09, 2019 3:40 pm
To be sure, with margin account, so for the time the option is sold but not exercised, no money is borrowed so no interest paid. Is that correct?
Yes.
With NO margin account, which is my current situation. The amount $ for the option (strike * 100) is blocked since the beginning as cash. I am trying to validate, that margin account solves this and unless exercised it is "free". Any obvious drawbacks I do not see now?
I assume I am comfortable with the stock and strike price when exercised.
In order to have margin, you have to have assets with the broker.

For instance, you write one Put 100. The broker will want you to have $10,000 with him to cover an exercise.
You can have $10,000 in cash and a cash account, or you can have stocks valued $20,000 and a margin account.

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305pelusa
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Re: Selling put options - interest paid

Post by 305pelusa » Tue Jul 09, 2019 8:58 pm

Thesaints wrote:
Tue Jul 09, 2019 8:51 pm

For instance, you write one Put 100. The broker will want you to have $10,000 with him to cover an exercise.
You can have $10,000 in cash and a cash account, or you can have stocks valued $20,000 and a margin account.
AFAIK, this is not correct. The margin requirements for an uncovered put (in a margin account) are (20% of the strike price + put premium - moneyness of the put). Some brokers will use 15% if it's an index put. This margin requirement can be satisfied with cash. So you can maintain an uncovered put in a margin account with less cash than a covered put (in a cash account).

You can also use stocks (as you hinted at) to satisfy the margin requirement. Some brokers will count each "stock dollar" as less than a dollar (say 50%) for purposes of margin. That's known as a "haircut". Some do not haircut your stock positions.

OP has it right. A margin account lowers your margin requirements. It also lets you satisfy them with stocks.

Thesaints
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Re: Selling put options - interest paid

Post by Thesaints » Tue Jul 09, 2019 11:49 pm

305pelusa wrote:
Tue Jul 09, 2019 8:58 pm
AFAIK, this is not correct. The margin requirements for an uncovered put (in a margin account) are (20% of the strike price + put premium - moneyness of the put). Some brokers will use 15% if it's an index put. This margin requirement can be satisfied with cash. So you can maintain an uncovered put in a margin account with less cash than a covered put (in a cash account).
If we want to get technical, in a margin account naked puts are required to

1) have a minimum account balance and be approved for the appropriate options trading level (10's of thou and lvl 4 or 5)

margin is the higher of:

a) 25% of stock/index value (20% for broad indexes), plus option premium, minus the out of the moneyness.

b) 15% of strike value, plus option premium.

premiums are calculated using the ask value.
You can also use stocks (as you hinted at) to satisfy the margin requirement. Some brokers will count each "stock dollar" as less than a dollar (say 50%) for purposes of margin. That's known as a "haircut". Some do not haircut your stock positions.
depending on portfolio, margin amount can be above 50% of portfolio value and that doesn't even have to be the current value but the high mark within a certain time span.

ralph124cf
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Re: Selling put options - interest paid

Post by ralph124cf » Wed Jul 10, 2019 7:43 pm

Thesaints wrote:
Tue Jul 09, 2019 8:34 pm
ralph124cf wrote:
Tue Jul 09, 2019 7:42 pm
A put option is another way to enter an out of the money limit order. You decide that you would like to buy this stock, if it falls by a certain amount. Unlike a limit order, you collect a small premium for writing the order.

Ralph
They are quite different situations.

XYZ trades at $50

A enters a limit order at $45
B writes a Put strike 45 and cashes, let's say, $2

Bad news! XYZ business is flawed. SEC is on their tail and may impose heavy fines. Cost of whatever raw material they use spikes up.

XYZ now trades at 47 trending down

A simply cancels his order in the light of these news.
B instead is holding this hot potato he needs to get rid of. Too bad now the same Put trades at $3 and he loses $1 + the cost of two trades.
Neither a buy limit order or selling a put option is appropriate for a person who is able to monitor the market real time,which is what your scenario requires. Both of these is for the person that is not connected at all times. For these people, the limit buy order would have resulted in a two dollar/share price disadvantage compared to the put sale option. Both would have resulted in buyng the stock at the $45 strike price, but the put option selller would have the $2/share option price in hand.

Ralph

Thesaints
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Re: Selling put options - interest paid

Post by Thesaints » Wed Jul 10, 2019 7:48 pm

I did not say how long it takes XYZ to go from $50 to $47. I guess one who buys individual stocks is expected to at least check the news about that company fairly regularly. Otherwise, why would they buy XYZ and not UVW ?

Topic Author
jirikv80
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Re: Selling put options - interest paid

Post by jirikv80 » Thu Jul 11, 2019 10:22 am

Thank you for helpful and knowledgeable advice, I like mentioned the comparison between selling put options and limit orders. Broader index ETF should give more safety than individual stock for unexpected situations.

I still like the idea of switching from cash account to margin account for careful option trading.

As mentioned, there is also initial margin requirement counted before the option is exercised.

Sharing also info from my broker:
If you have positive funds to meet initial margin requirement then there will be no interest charged on your account.
If you do not have positive funds to meet margin requirement then interest will be charged.

Short Naked Put
Stock Options
Put Price + Maximum ((20% * Underlying Price - Out of the Money Amount), (10% * Strike Price))

Index Options
Put Price + Maximum ((15% * Underlying Price - Out of the Money Amount), (10% * Strike Price))

https://www.interactivebrokers.ca/en/in ... 1004100808

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