When you short/write an option, its unlimited loss more risk when compare to buy an options,no one will ready to pay the losses after trading thats the reason brokers collect high margins.
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Buying an option risk will be limited to premium & profit is unlimited compare to limited profits in writing an options & loss will be unlimited for that exchange will collect the huge margins from the clients
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Hi,
Option writing means writer is obligated to sell his call/put option to buyer on expiry date,so in market we canāt predict the market volatility thatās the reason option writer need more margin then compare option buyer.
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When you buy options, the maximum risk is just the premium hence you pay the premium there no additional risk to the broker.
But,
When you write/short the options the maximum risk is unlimited so to protect against the risk, broker collects the margin.
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For the Nifty 7500 Call, since you are the buyer of the option, you only have to pay a premium, to get the right to buy Nifty at 7500, which in this case is Rs. 2500. Hence your loss is limited as there is no liability except the premium and that is the maximum loss you can incur while buying a option.
On the other hand, when you are selling a call, you are giving rights to other people to buy Nifty at a particular price and are obligated to sell Nifty at 7500, come what may, which can result in unlimited loss. Hence the margin required for writing options is higher then buying options.
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Buyer of an option has limited risk and unlimited profit
Shorting of an option has limited profit and unlimited risk.
Since shorting of option has unlimited risk, exchanges prescribes a margin called SPAN margin which is almost equal to futures margin to avoid the unlimited risk.
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When ever you sell an option without a buy position, it is called as writing an option. The risk is high when you write an option and exchange blocks margin when you write an option. In buying option the risk is limited and profit is unlimited.
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Before knowing why there is more margin to short an option when compared to buy an option, one should know what does option writing means.
Option writing/shorting is the act of selling either calls or puts first, hoping that the value goes to zero or buy it back at a lower price to earn a profit.
When you write an option, you are exposed to unlimited risk in exchange for limited profit.To put it very simply, whenever you have positions with risk potential greater than what you paid to get the position, margin would be required.
To conclude, the principle behind options margin is that of making sure the writer is capable of closing the position without being in default.
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- Short selling can offer quick profits, but also high/unlimited riskĀ hence exchangeĀ require more margin
- Ā Buying options, the most that you can lose is the premium that you have paid for them, while the potential profit is high.
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The logic that why the broker asks for more margin in selling / writing of options (calls or puts) is as underā¦
When we sell something which we do not own means we are lending from someone ( here it is broker firm) and selling it out . This involves high risk and we have to bear in mind that we have to return it back in future by buying it back.Now since we have shorted it or written down options we have created a liability for ourselves.which increases to unlimited if the trade goes against us that is if the prices of the options rise high and keep on surgng towrads north.In such a case at times we are not in sound position to pay back the liability therefore that huge margin is required when we sell the options because they are for that back up purpose.
(i have tried to explain in simple way avoided using any technical term )
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When you short/write an option, you run the risk of unlimited losses which is why brokers ask for higher margins. Where the loss is unlimited and profit is limitedā¦
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. Where the loss is limited and profit is unlimited.
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While buying an option, one has to just pay the premium, as the risk is limited. Whereas when selling/ writing an option, one has to pay margin money, as there is unlimited risk involved. Margin requirement is specified by the exchange for various contracts/ strike prices.
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Hi
Short an option, theoretically you run the risk of unlimited losses which is why brokerages ask you for higher margins. Shorting is completely opposite your profits are limited to 2500 & loss are unlimited, thatās why exchange charges more margin for shorting.
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.
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Margin requirement is more in writing option because Maximum risk is involved when writing an option, when compared with a option bought,. There is a limited profit & maximum loss in writing option but in Buying a option there is maximum profit & limited loss. When an option is bought it gives the right to exercise your option and the risk is limited as maximum loss is the premium paidā¦
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As it involves high risk, option writing is costly and require more margins.
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Buyer of an option has limited risk and unlimited profit and Shorting of an option has limited profit and unlimited risk. Hence margin required is more
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The reason why margin required for option writing is more because to write an option the profit is limited but there is unlimited loss associated with option writing
While buying an option margin required is less because losses are limited and there is unlimited profit
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Money required for shorting and buying option differs based on the risk (loss) which the trader incur,
In shorting option risk involved is unlimited but limited profitā¦ Where as in option buying itās the reverseā¦ No trader will be ready to pay the losses so easily once the transaction is executed; hence shorting requires more money than buyingā¦
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Hi,
As we know that when we buy options( long) we need to pay only Premium value which restrict our loss. and when we sell the options( Shorting ) we will receive only premium value and here seller have an obligation to buy the option hence seller is taking more risk with having unlimited loss he need to pay give more margin.
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While writing an Option the risk is very high. The profit is limited but the losses are unlimited. Hence, the margin requirement is also high.
Where as while buying an option the Profit is unlimited and loss is limited to the premium paid.
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