Query regarding writing covered calls with collateral

F&O
1

Presuming I have INR 5,00,000 cash in my trading account and I plan to start a covered call strategy for Reliance.

So I buy 250 shares of Reliance at 2000 per share. A total of INR 5,00,000.
Trading account balance is now 0.

Then I pledge these 250 shares. Presuming the haircut is 20%, I get collateral margin of INR 4,00,000.
I now add INR 50,000 cash to my trading account.

It takes INR 1,00,000 to sell a call.
So let’s presume I sell 2040 CE at 50 rupees.

Since writing calls requires 50% in cash, and 50% in collateral - 50k of my collateral is used, and 50k of my cash is used.

That leaves me with 0 cash and 3,50,000 in collateral.

After two weeks, let’s presume that the price of Reliance increases to INR 2100 and the price of the 2040 CE increases to INR 100.

Here are my questions:

  1. The value of my Reliance shares is now 2100 x 250 = INR 5,25,000.
    So will the value of my collateral margin increase to 80% of 5,25,000 = INR 4,20,000 (minus 50,0000 for writing the call) - So will it be INR 3,70,000?

The cash balance in my account at the start of this trade was 0.
In this case, the naked written call has a loss of INR 12,500.

(1) I’d like to know if my account will show a debit balance - and will I be forced to add 12,500 to my account to keep the positions open - so that they don’t get squared off by the RMS?

(2) Or - will the INR 12,500 be deducted from the collateral margin of INR 3,70,000 - and my margin will now be 3,57,500, and my cash balance will continue to stay 0.
(let’s hypothetically presume that the margin requires stays constant at 1,00,000 per lot for the sold call)

If (2) option is correct, then I’d like to know at what point (how much losses can I incur on the written call) will I be forced to add cash to my account, so that the position is not squared off my the RMS?

Thank you.

@ShubhS9

1 Like
2

For options there is no marking to market, means profits are losses are not considered till position is closed, but what will happen in this case is your span and exposure requirement will go up. So, one need to maintain that always.

Margin will be maintained as you have collateral so there will be no penalty or rms won’t square off of your position.
But as margin requirement should come form 50% cash and rest from collateral there will be interest penalty on how much you are short of cash.
As initially it require 1 lakh to short this but now it may require 1.1 lakh so 10k is increased, 5k will come from collateral and remaining 5k should come from cash so in this case if you don’t have cash then interest penalty of 18% per annum will be levied on shortfall of 5k.

3

Cash collateral will do too, correct?

4

Thank you @siva

Quick follow up question. Sorry, if this sounds stupid - but just wanted to confirm:

Presuming my cash balance is 0 after executing the strategy.

And four days before expiry, I decided to square off the sold call position - let’s say the loss is -60k.

Now at this time, I need to have at least 10,000 cash in my account right?
Otherwise, my account will be in debit at -10k. (Since I originally had 50k cash in my account).

1 Like
5

@Vij

Yup. I’ve tried writing options using only cash collateral. It works.
Need cash to buy any options for hedging, though.

6

I know :slightly_smiling_face: I was just adding to what @siva stated. When span and exposure goes up due to unrealised losses in options, you don’t need additional cash, even cash collateral is sufficient.

7

hey Vij, do we also need to increase margin in case a bull put spread goes deep in the money during a crash ? To initiate a position it requires around 35k to 40k and suppose we have just that much margin, then if one side of the leg is in deep loss of say 60k, then we’ll have to put up more margin ?

8

Yes. Margin will increase. Which is why I’m not comfortable using up all margin on initial trades (unless i can bring in cash), and not leave room for adjustments and ongoing unfavourable trades. I know some experienced traders do tat though and then rely on juggling btw existing trades. All power to them.

9

Obviously, Above he is asking for reliance eq pledging to write covered call on it.

10

Correct.

11

Thank you for your prompt support @siva.

Also - If the cost of my Reliance increases from 2000 to 2100, will the value of my collateral margin also increase by INR 100 x 250 shares = INR 25,000 x 80% = INR 20,000?

12

Ah, right. Thank you for adding that point. :slight_smile:

13

Yes, it does for next trading day.

14

Thank you for getting back @siva

From what I read, if I receive INR 4,00,000 collateral margin from the Reliance shares, I think I can use the entire INR 4,00,000 to buy / sell options intraday?

Or do I need to furnish 50% cash even if it is for intraday options trading?

Thank you.

15

Collateral margins are used only to sell options or trade futures but not for buying options.

Intraday should be okay, there will be no penalty.