The superiority of spreads and their absolutely dismal state

[nithin]

@Avi_Garg

Let’s just say a debit spread is being created. Then the short leg is already hedged by a relatively ITM long option. Now, apart from the net debit value, we are required to bring in exposure margin as well. Now, if there is a change in exposure margin due to whatever reason, we are required to bring in that margin and failure to do would result in square cause this is the margin required to hold our position. Yes or no?

Yes.

@Avi_Garg

Now, let’s take the same debit spread. If the price moves in my favor, then both options will gain value. The short option would be losing obviously but the long option would gain much more than the short option. Nonetheless, I assume from what you have earlier that we are required to pay for the losses in our short from our free margin. Is that correct? Yes or no?

@Avi_Garg

What does it mean when you said that margin goes up slower in the case of a spread?

Yes. What I was telling you was that there is no concept of MTM for short option positions like in futures. Check this explanation.

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Glad you liked the content on Varsity, Shivam You need to keep track of both the price and volatility, margin is a function of both. Margins increases if the price moves against your position or if the volatility increases. For example, if the price increases from Rs.30 to Rs.100, then the margin requirement will go up by Rs 8500 ( Rs 70 x 50). But at the same time, if the volatility drops, then margins may stay intact. So it is really a function of price and volatility. Let’s …

In futures, whatever is the loss on one side is collected and paid to the client on the other side of the position. In options, the option buyer doesn’t get money credited like in futures if say the short option holder loses money. The way it works with short option trades is that when position goes against you, the margin required to hold the position increases & indirectly acts like MTM. The margins don’t necessarily go up as much as your loss. So for example if you short 1 Nifty 17200 calls at say Rs 100 and premium Rs 1lk. If the premium goes to Rs 200, the margin requirement to hold this may not be Rs 1.05 lks (Rs 1lk + Rs 5 loss), it could potentially be Rs 1.03lks. It depends on the SPAN.

@Avi_Garg

If we fail to pay for the losses of our short option for the same spread that I am taking as an example, does the broker square off our positions? Yes or no?

Like I explained, if your margin to hold the spread goes up and if your account doesn’t have sufficient margins to hold it, yes, it will get squared off to avoid exchange penalty on the account.