When you go long a call spread(that is when you go long a call option of a lower strike and short a call option of a higher strike, with both having the same expiry), you cannot lose more than the amount you initially pay. Technically, there is no reason to hold a margin beyond this amount.
When you go short a call spread(that is when you go short a call option of a lower strike and long a call option of a higher strike, with both having the same expiry), the maximum loss possible is the difference of two strikes multiplied by the contract multiplier. There is no reason to exact a margin bigger than this amount.
However in both these cases, brokers look to be exacting much bigger margins (Zerodha for example, takes around Rs.14000 as margin for a short call spread when the maximum risk possible is Rs.1250. They told that they look into this issue as an enhancement). This can hinder traders from placing more trades with their available capital.
Can someone chip in with their comments on this? Wanted to hear opinions from experts on this! (It would be great to hear opinion of @nithin sir on this, as well!)
Brokers has no role in deciding required margins, they just block what is required by the exchanges, all brokers block the same. Exchanges has their own internal models but mainly they follow SPAN.
Thank you @siva for your reply. I have a followup question on this:
If that is the case, shouldn’t exchange ensure that the margin required does not exceed the maximum possible loss of the portfolio? I understand exchanges requiring a huge margin for naked short option positions, but shouldn’t it be much lesser for limited risk positions? The benefits for these are paramount, and I am listing them below:
This can enable to traders to make maximum use of their capital.
This can also incentivise traders to go for limited risk positions, thus reducing their potential losses.
This can increase trading activity, benefitting both brokers as well as exchanges.
This is obvious, but a trader can try to break the hedge and exit buy leg leaving a sell leg with much lesser margin, this increases risk to the overall system.
Systems should be built by exchanges in such a way the spread leg can’t be broken on one side and if user want to exit he should exit full spread if not none, so till then this continues.
Systems should be built by exchanges in such a way the spread leg can’t be broken on one side and if user want to exit he should exit full spread if not none, so till then this continue=
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Isn’t this possible even now? A naked short NIFTY call can have a margin requirement of Rs.42000 whereas a corresponding short call spread can have a margin requirement of only Rs.14000. So can someone go short a call spread and get rid of the long position of the spread to have a naked short option position with a margin of Rs.14000? I haven’t tested this, but was thinking that I would be blocked from getting rid of my long option position if I did not have Rs.42000 in my account.
If I could do the above mentioned hypothetical trade, then this is something that needs to be fixed now. And doing it the right way, can ensure that margin truly reflects the risk of the portfolio.
So if I want this to change, what should I do ? Should I contact the exchange or SEBI? Given that they are the ones who set the rules regarding margin, I guess that is the most sensible thing to do.