November 5, by m slabinski. A margin account is a type of brokerage account that gives the account owner the ability to borrow money from their brokerage. The brokerage lends money at a given interest rate, allowing the margin account owner to invest more money than they initially had in their account. The brokerage uses cash and securities in the account as collateral for the money they lend.
The more collateral an account has, the more money a brokerage will lend to an account. We can think about this like taking a loan out against a house. A brokerage, like the bank, can also sell the collateral marginable securities in a margin account to recoup money that is not paid back. We will talk about this in more detail in the last section on margin calls.
For options trading, we primarily see margin accounts discussed when it comes to the amount of buying power required to place an option trade.
If we sell an option or spread, we take on a certain amount of risk. To cover the amount of risk in a position and our entire portfolio, the brokerage requires us to have a certain amount of collateral. For example, if we sell a short put, the brokerage requires we keep a certain amount of capital available in case the position moves against us.
Having a margin account allows us to place option trades for less buying power, giving us more leverage. In a margin account we are required to put up less collateral buying power when we take on risk in our trades, compared to an IRA or non-margin account. Buying power is a measure of how much capital we have available to put on new positions given our current portfolio current positions, account type, and amount of cash in the account.
Our buying power tells us how much money we can initially use towards new trades. We can think about buying power as the current value, as collateral, the brokerage gives our account. When we place a new trade, taking on more risk, we use our buying power as collateral for the trade.
Depending on the underlying, strategy, and our account type, the option trade will use different amounts of buying power. As the market changes, the amount of buying power required by the position might change as well. It is important to monitor the amount of buying power available in our account, so we do not get too close to using more buying power than we have causing a margin call. When making trades in dough, we can see the buying power reduction for defined risk trades in the bottom left of the trade scorecard pictured to the right.
It is important to realize that the buying power reduction and notional value are not the same in most cases. There is potential to lose more than the buying power required by the brokerage. Trading smaller in underlyings allows us to diversify our risk and increase our number of occurrences in other trades. A portfolio margin account is a type of brokerage account that uses option pricing models to calculate risk, instead of percentage calculations like in a regular margin account.
Portfolio margin accounts provide more leverage than a regular margin account because they calculate risk differently.
A margin call occurs when an account runs out of available buying power and the brokerage contacts the account owner to deposit more cash or close positions to free up capital in the account. The brokerage deems that the account carries too much risk in comparison to the value of the account or for the amount of money they have lent.
The account would receive a margin call as the amount of buying power in the account and the account value are both negative. When an account receives a margin call, the account owner can satisfy the margin call by adding cash or securities to cover the margin difference or closing positions to free up more buying power. We avoid margin calls by keeping a close eye on our portfolio buying power, trading small in underlyings, and diversifying our risk different strategies, time horizons, and underlyings.
Trading in a margin account allows us to increase our leverage. The buying power reduction in a margin account is less than in a cash secured account. We avoid margin calls by watching our portfolio buying power, trading small in underlyings, and diversifying our risk. Still have questions about trading in a margin account?
Email us at support dough. Beginner intermediate Blog Sign Up Login. Trading Options in a Margin Account. What is a Margin Account? What is Buying Power? Generally, the more potential risk in a trade, the more buying power it will require. What is a Portfolio Margin Account? What is a Margin Call? An example of this could be the following: Trading in a Margin Account Recap.
Oct 21, beginner , Ryan Grace , education , Ryan and Beef Show , Michael "beef" Hart , brokerage account , defined risk , delta , POP , portfolio page , risk management , undefined risk m slabinski Comment. Break out the metaphorical tape measure, because Ryan and Beef are about to measure some risk. Oct 7, beginner , Michael "beef" Hart , Ryan Grace , trading strategy , Ryan and Beef Show , bearish , cost basis , puts , stocks , undefined risk m slabinski Comment.
Tired of trying to tame the bull? Jun 22, beginner , Mike Butler , Mike and His Whiteboard , program , dough follow feed , risk management , trade management , defined risk , undefined risk m slabinski Comment.More...