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Hey everyone, Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to talk about the basics of trading options with margin. I think this is an interesting topic to talk about because most people who get started on options trading, they understand that they have to open up some sort of account that allows them to do trading. One of the accounts that you can open up is what’s called a margin account. And so, I want to describe basically what margin is and why it’s available, what happens, how it’s used to cover positions, etcetera. Basically, what is margin and why do you need it? Well, to understand margin, you have to first understand that it mostly applies to option sellers. Now, some accounts may apply margin to option buyers, but it’s not traditionally how it’s done. When you start trading options, if you buy options as the first course of business which most people might start by buying an option contract, they buy a call or buy a put, those contracts do not require any margin and they don’t require any margin because those contracts are contracts where you outlaid money and you have the potential to lose that money, but you had that money in place to begin with, meaning if an option contract cost $100, you paid $100 to be able to get that option contract. The brokers understand that you understand because you paid the money for it, that you have the ability to lose $100 on that trade. Your risk is covered by the initial investment that you already made in that contract. Hopefully that makes sense. You are covering yourself by buying that contract. You're risking your own money and you could lose that money. Now, when you start trading options and start selling options where you are no longer an option buyer, but an option seller, collecting a premium and then basically promising to pay out if you lose, that's when margin accounts come into play. Margin accounts then allow the broker to allow you to sell options and what they do is they basically take a chunk of money from your account and basically put it aside to cover the risk in that trade. It’s not that they physically remove the money from your account, but they basically say, “Okay look. If you've got $10,000, then $1,000 is going to be put aside in your account, is going to be sectioned off if you will, partitioned from your ability to trade because that $1,000 has to cover the new option contract that you just sold.” If you sold an option contract for $100, so let’s say you’re on the other side of our example that we used in the beginning of the podcast, now you sold an option contract for $100, you collected a premium as an option seller from the option buyer, but now you have to put aside some money in your account in case the trade just goes bad. That's really what it comes down to. You have to put some margin of capital in your account aside in case you're wrong and the contract goes up a ton in value and you have to let’s say buy back the contract in the open market for $500, so you lose $400 in total. You have to put some of that money aside in your account. Again, brokers do this automatically through what’s called a “margin schedule.” They put aside money based on implied volatility, expected move in the stock, percentage thresholds that they use. Different brokers have different schedules, so check with your broker, understand what they do. But they put that money aside to cover the potential loss in that position. Now, in most cases, they put aside like let’s say the loss that might happen at a two standard deviation level. Go back a couple of podcast. You can listen to the one that we did on expected moves. But they would calculate – “Hey, how much money could you lose if the stock makes a two standard deviation move?” Great, then we’re going to put aside that amount of capital in your account. It’s a very common thing to do. But again, it’s not that they’re taking that money out of your account. They’re not withdrawing it. They’re just not allowing you to trade it. They’re not allowing you to invest and double down on your bets by also trading your $1,000 and buying something else because you’ve got to have money to make good on your position. That's really what it comes down to. This entire market is predicated on people making sure (and brokers and clearing houses and exchanges) that if you say you are going to enter into a contract and somebody else enters in that contract with you, that both parties have the capital resources to make good on that contract. That’s how efficient markets really work well, when both parties have the resources in place to either pay out if they lose or to have the ability to collect if they win. That has to be a factor in efficient markets. And so, that’s where margin comes into play. Again, you don’t have to have a margin account to trade options. Margin accounts are ways that you can trade undefined risk strategies. You can trade defined risk strategies in any IRA, retirement account, etcetera where you have defined risk. The only difference between let’s say a traditional margin account and being able to trade elsewhere is that strategies in most cases have to be defined risk, meaning you can’t have naked lingering options, naked calls, naked puts, etcetera. Everything has to be basically a spread. You have to buy a call and sell a call at the same time or sell a put and buy a put at the same time and do a spread. You do those, you still have the ability to do those in other types of accounts. Hopefully that helps out. Hopefully maybe it clears the air and gets you started if you're just getting started with options trading and learning some of the basics. As always, if you have any comments or questions, let me know. Until next time, happy trading!