# Hab Technology

Thoughts of a mechanical engineer turned programmer turned statistical investor. Here to save you from making mistakes I made at the beginning of my investing career.

## Portfolio margin explained

I got a question on this post about portfolio margin so I’ll dedicate a short post to how it works.

Say I sell a \$100 AAPL put. Thats a promise to buy 100 shares of AAPL for 100\$, costing a total of 10,000\$. I happened to sell such a put in my portfolio (as well as 2 105\$ puts):

The 100\$ put has a current value of 740\$, and a requirement % of 15%. 15% of 10,000\$ is 1500\$, plus the value of the puts (740\$) is the 2240\$ requirement \$. So instead of E*Trade requiring the full 10,000\$ of cash required to purchase the shares and to leave them in the account until expiry (also called a cash secured put), its only requiring 2240\$, so significantly less (also called a naked put). So the margin rate on AAPL is 15%.

Here are a couple other short put positions I hold and their margin rate:

So similar to AAPL, the margin rate for LMT is also 15%. MTCH has a slightly higher margin rate of 20%. RIVN as you can see has a margin rate of 100%.

More established, large cap companies usually have a lower margin rate (AAPL, LMT), whereas smaller, newer companies with less history have a higher margin rate (RIVN). The rationale behind the margin rate is that there is a possibility that AAPL will go down below 100\$ (the put strike), but the probability that they will go completely bankrupt and the stock will go down to 0 is very (!) low. On the other hand, there is a significant possibility RIVN could go bankrupt, forcing me to buy the 100 shares for 20\$ (\$2000). If that money isn’t in my account, E*Trade would need to spot that bill, which they obviously don’t want to do.

So in theory, say I have 10,000\$ in my account, I could sell 1 \$100 put on AAPL, as a cash secured put, pocket 740\$, and wait for the position to expire. Or, if I have a margin account, I could sell 4 of the same puts, pocket 740*4 = 2960\$, as that would require 2240*4 = 8960\$ of cash to cover the position, and I have 10,000\$. The danger with doing that is if AAPL goes down, the short put value will go up, and since the margin requirement is calculated as:

price of position if exercised * margin rate + position value, so in the case of 4 contracts:

40,000\$ * 15% + 2960 = 8960\$.

If the value the position goes up significantly (say to 8000\$, the margin req will be 6000 + 8000 = 14,000, but you only have 10,000\$ + 2960 (credit from selling the puts) in the account, and you will get whats called a margin call, forcing you to buy to close 1 (or more) of the short put contracts for a loss, for the high current price (even if only temporary), wiping out all the potential gains you would have made, and probably more.

So thats the danger of selling naked options, and why its super (!!!) important to have spare cash on the side to cover the increased margin requirements if the position goes against you.

So for the previous example, if instead of selling 4 contracts you had sold 2 (still more than the 1 cash secured put), the margin requirement will be 20,000 * 0.15 + 740*2 = 4480\$, and since you have 10,000 + 1480\$ = \$11,480 in the account, even if the positions temporarily lose 5000\$ in value, you’re still ok as you will still satisfy the margin requirement of the position, enabling you to wait it out and hopefully it will still expire the way you hoped at the beginning.

So to summarize:

Selling naked puts vs cash secured puts enable you to leverage the cash deposit in your account, enabling you to make (and lose!) more money in the same amount of time, by selling more contracts. If used responsibly, its a great way to boost portfolio return, otherwise its a great way to wipe out your portfolio value, so best to start small and proceed carefully.

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