How to Calculate the Initial Margin for a Short Strangle

 

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Original post by Jonathan Langsdorf of Demand Media

A short strangle strategy in options trading is the simultaneous sale of an equal number of out-of-the-money call options and out-of-the-money put options on a particular stock. The trade is established as a credit to the trader's account. Ideally for the investor, the underlying stock remains between the two strike prices when the options reach expiration. The required margin deposit provides a monetary cushion if the stock price moves either above the call strike price or below the put strike price, placing the trade in a loss position.

Step 1

Write down the premium received for each side of the strangle, the strike prices for the calls and puts, and the current price of the underlying stock. For example, assume a short strangle on Microsoft has been initiated, and that Microsoft's stock is at $27 a share. One put option is sold with a strike price of $26 with a premium of $140. The sold call option has a strike price of $28 and the premium was $85.

Step 2

Multiply the current stock price, the call option strike price and the put option strike price times 100, times the number of contracts traded on each side of the strangle. Option contracts are for 100 shares of the underlying stock per contract. In the example, the results are $2,700, $2,800 and $2,600 respectively.

Step 3

Multiply the current share price times 20 percent, subtract the amount the call option strike price is out of the money, and add the amount of call option premium received. For the Microsoft strangle: 20 percent of $2,700 is $540, minus the $100 the call is out of the money -- $2,800 minus $2,700 -- plus the $85 premium received equals a total of $525.

Step 4

Repeat the previous calculation with the put option numbers. In the 20 percent of $2,700 is $540, minus $100 out-of-the-money, plus $140 option premium equals $580.

Step 5

Multiply the call option exercise value times 10 percent, then add the call option premium. For the example, the call exercise value is $2,800. Ten percent is $280 plus 85 equals $365.

Step 6

Repeat the above calculation for the sold put option. In the example, 10 percent of $2,600 is $260 plus $140 equals $400.

Step 7

Select the largest calculated value from the four previous calculations and add the premium received from the other option sold. In the example, the first put calculation is the largest amount at $580. Adding the call option premium of $85 gives a total initial margin requirement of $665. The margin deposit will be the $225 received as option premiums plus an additional $440 from the trader's account cash balance.

http://wiki.fool.com/How_to_Calculate_the_Initial_Margin_for_a_Short_Strangle