Why do I require so much more money to short options as compared to buying options?

#1

Nifty 7500 calls if trading at Rs 50, I need only Rs 2500 to buy it if I expect the price to go up, but if the same option I have to short expecting the price to go down I need almost Rs 25000 to take this position. Can someone explain why?

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#2

Tarzan,

When you buy option entire premium amount is debited to your account.The option value cannot go below zero . Maximum loss is 2500 RS.

When you write options margin requirement is high due to unlimited loss involved in them. Maximum Profit is 2500 RS in your scenario.

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#3

Options writing persist to maximum/unlimited risks hence they require more margin and also the settlement happens same as futures i.e daily mark to market. The broker lends you the script to sell it and buy it back before the expiry. During this the exchange calculates 16 various scenarios in which you can incur losses to the exchange and asks for the maximum amount.

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#4

Shorting/Writing options implies selling an option without owning it.

When you short/write an option, theoretically you run the risk of unlimited losses which is why brokerages ask you for higher margins.

When you buy an option your losses are limited to the amount of premium you pay which is not the case when you short/write an option.

So in the above example, if you bought 7500 at Rs.50, you’d pay a premium of Rs.2500 and at no point will you stand to lose more than 2500. However if you’ve shorted 7500 CE @ 50, and if the markets bounce and if the value of 7500 CE goes to 200, your losses would be (200-50) = 150*50 = Rs.7500, so potentially you can lose any amount of money which is why brokerages charge you higher margins.

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#5

Because risk is unlimited and profit is limited on short option,.(short option strategies),
and risk is limited and profit is unlimited on Buy option.(Long option strategies) that’s the reason more margin is required.

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#6

There is difference between option buying & shorting .

Buying is required full money i.e is premium*qty & here the risk is limited maximum you can loose is rs 2500 & profits are unlimited.

Where in shorting it is completely opposite your profits are limited to 2500 & loss are unlimited, that’s why exchange charges more margin for shorting.

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#7

Buying option indicates your loss is limited to premium paid ie., 50/- of 7500 call and profit is unlimited when you short call option at 50/- of 7500 call your profit would be 50/- ie., premium where as loss is unlimited since loss is unlimited margin(high) amount is kept for safeguarding position with unlimited loss

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#8

When you write/short an option, the risk is higher if the value of the premium is more and risk is lower if the value of premium is less. so in the above case when we buy option only premium amount as to pay that is 2500 risk involved is only premium when we write option margin is high because limited Profit and unlimited loss so for writing options exchanges will block more margin.

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#9

For sure the risk is unlimited in writing an option compared to buying which is limited to the premium. And moreover when you write or sell an option, you are receiving a premium instead to paying. So this premium too that is been received needs to be added to the overall margin required. This is the main reason why the margin for writing ITM options is higher because the premium receivable is more.Option writing margin is calculated on similar lines to futures margin which is based on SPAN and VAR + Premium receivable added. However it cannot be considered exactly as futures trading because there is a premium added plus the daily mark to marking is not as simple as the futures. 

Simply speaking  the margin required for writing is more than buying because- RISK IS UNLIMITED & PREMIUM IS RECEIVED not paid.

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#10

When you buy options, it will give you unlimited profits with limited loss, whereas when you write/sell options, it gives you unlimited loss with limited profit (Rs. 2500). Hence, it is risky when you write options, so margin requirement is higher.

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#11

In the above scenario, if you buy options the maximum loss you will make will be Rs.2500 which will be already debit from your account as premium, but when you short an option the loss one can make is unlimited and profit will be limited to Rs.2500, so brokers ask for more margin while shorting an option.

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#12

Hi,

Buyer of an option has limited loss but unlimited Profit with the right but not the obligation to buy or Sell the underlying option. Whereas seller of an option has Profit limited to premium received but unlimited loss with obligation to purchase or deliver the underlying assets.

Making it Simple, Suppose you are willing to buy a mobile which is now available at Rs .45000 which is in high demand and price may rise up and suppose you don’t have enough funds now. So you go to a seller and deal with him by giving Rs 1000 now that you will buy the same mobile after 1 month at current price and your deal is sealed.

After one month, let’s say mobile price is Rs 48000; you can go to the dealer pay rest Rs 44000 and exercise the deal. So in this case, Seller of the mobile is in loss because he is selling the mobile (48000-45000)=Rs 3000 below the market price and his loss will continue till the market keeps on increase since he is obligated to deliver the mobile. Hence he has unlimited loss.

The Profit will only be Rs 1000 which is received if price goes down and Buyer will not exercise the deal.

Exchange derivatives are all cash settled, No actually deliver happens.

In Your example, If you short one lot of option 7500 CE  at Rs 50 = you receive Rs 2500 as a premium but If market roses up, the Premium will also go high from 50 to 100 ..150 which will depend on % increase hence loss from a writer of the option will be huge.  

Hence margin collected from the seller or writer of the option is huge. It is basically combination of (SPAN + EXPOSURE + PREMIUM RECEIVED).

Margin keeps increase if you short or write more In the money options.

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#13

buyer of the option only pays the premium for that contract…he has the choice…shorting option is risky bcoz he in the deal …marging req for shorting option is same as the margin req for future the seller of the option will receive the premium… and premium amt is included in margin…

ex:

22000 is req for shorting ATM option and 22000 is req for future

if he is shortin ITM he has to pay 22000 margin amt + premium (n he receives the premium)

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#14

For buying any option margin required is premium value i.e (7500 @ (50*50 = 2500)) and the loss is limited to the premium paid. On the other hand when you short/write an option, there is a risk of unlimited losses which is why higher margins are required.

               In the above example if you short Nifty 7500 CE @ 50, if Nifty goes to 7500(spot) then the premium trading may be around Rs 150/- & your loss will be RS 5000/- on this trade. So to cover this potential loss margin required for writing option will be more & varies depending on the strike price.
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#15

When one buys option, he pays premium for it. Buyer has a right but not the obligation to buy underlying asset. Whereas a seller of the option takes a risk of being obligated to sell the underlying. His profit overall is premium paid by buyer. His loss is unlimited. Hence margin required is more.

Thanks

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#16

Hi

Buying a call gives you the power to decide to exercise the option or not, So your risk is limited to the premium that you paid for the position. If it is not profitable to exercise you just walk away and your only loss is the premium. However, when you sell an option that power sits with the buyer and you then have the risk of being exercised. You do receive the premium but your losses are not limited like they are when you buy an option.

If the market does rally your profit potential varies between a long call and short put: a long call has potentially unlimited upside profit while a short put’s profit is limited to the premium you received when you sold the option.

So more margin is required to write an option instead of buying an option :slight_smile:

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#17

Writing or Selling of Options (call or put) involves margin money. The maximum positive potential for the Option Writers however, is limited to the extent of premium they collect. This strategy is to capture the erosion of premium value due to time decay. Writing options are a risky strategy and one has to follow the price movements closely.

For example:

By selling Nifty 7500 Calls, one can earn a maximum profit of around Rs. 90/- a contract (Friday’s Close) if Nifty stays above 7500. Due to time decay, the premium would decline, if Nifty stays or closes above 7500 towards expiry. On the other hand, if it moves against our position, I have to loss extra margin money, as desired by the exchange. If the Nifty Fall Down, say by 10 per cent, the option premium would jump sharply and so our losses and the margin money require.

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#18

When you short/write an option, you will be asked for more margin. This is because of the amount of risk involved in shorting/writing option. In option buy, buyer pays premium to the seller i.e., Rs.2,500 in your case. Whereas,in option shorting, risk (loss) is consider as unlimited and profit is limited and in option buy, the risk is limited to just premium paid and profit is unlimited.

Considering the risk factor, both exchange as well as broker demand’s for more margin in option shorting. But, there are hedge strategies where option writer get margin benefit.

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#19

At the beginning of the contract the buyer of the option has to pay only the premium and not the full price.The buyer of the option is not obliged  to exercise his option, and if he disregards or does not exercise his option he loses the premium paid. Therefore the buyer of an option has a liability that is limited to the premium that he must pay.

The seller has a limited gain but his downside risk is unlimited.The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right​. Therefore, the seller of an option has to deposit a margin with the exchange through his broker as security in case of an adverse movement in the price of the options that he has sold. The margins are levied on the contract value and the amount that the seller has to deposit is dictated by the exchange. 

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#20

Hi,

In writing option risk is more, than buying option. as in writing option limited profit and unlimited loss where as in buying option it reverse. Buying an option gives you the right to exercise your option and the risk is limited as your maximum loss is the premium paid.
The buyer of the option has the right to buy but not the obligation .where as the seller of the option has the obligation to sell as he has taken the premium. The profit of the seller is only the premium received and loss is unlimited.

So the margin requirement is more in writing option.

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