Investing in T-bills (Part 18)

As mentioned in the last full paragraph of Part 4, selling puts facilitates T-bill investment by raising cash balance. Short puts are proportional to overall risk, however, and such transactions are subject to specific maintenance margin requirements (MR).

[Initial MR is equal to] Maintenance MR for short puts [and] is calculated differently than that discussed for equities in Part 16. MR is the greatest of:

1. Current market value of option(s) + 20% of underlying stock – amount out of the money (OTM; otherwise zero) [1]
2. 10% of exercise value of underlying stock + premium value [2]
3. Premium value + $50/contract [3]

Example #1: sell six short puts on ABC (stock) at $80 strike price for $2.50 each with ABC at $81.25/share

    [1] ($2.50 x (6 x 100)) + [(20% / 100) x ($81.25 x (6 x 100))] – (($81.25 – $80.00) x 600) =
    $1,500 + $9,750 – $750 = $10,500

    [2] [(10% / 100) x ($80 x (6 x 100))] + ($2.50 x 600) = $4,800 + $1,500 = $6,300

    [3] ($2.50 x 600) + ($50 x 6) = $1,500 + $300 = $1,800

    $10,500 is greatest (the 20% MR [1]).

Example #2: sell six short puts on XYZ (stock) at $70 strike price for $0.75 each with XYZ at $81.25/share

    [1] ($0.75 x (6 x 100)) + [(20% / 100) x ($81.25 x (6 x 100))] – (($81.25 – $70.00) x 600) =
    $450 + $9,750 – $6,750 = $3,450

    [2] [(10% / 100) x ($70 x (6 x 100))] + ($0.75 x 600) = $4,200 + $450 = $4,650

    [3] ($0.75 x 600) + ($50 x 6) = $450 + $300 = $750

    $4,650 is greatest (the 10% MR [2]). This is just Example #1 with a lower strike price (hence lower premium) selected.

MR is proportional to number of contracts because the latter gets multiplied by every term in each calculation. In Example #2, MR is therefore $4,650 / 6 contracts = $775/contract. For 12 puts, MR would be: 12 x $775/contract = $9,300.*

A maintenance call (see fifth bullet point) will be issued when:

MR > market value of securities + free cash – debit balance [4]

• Market value of long (short) securities is positive (negative).
• Market value of OTM short options increases to zero at expiration.
• Debit balance is the loan amount when borrowing funds from the brokerage.*
• Customers typically have two business days to satisfy a maintenance call by falsifying [4] else the brokerage will close positions at its discretion (potential worst-case scenario as catastrophic loss may be locked in).

While short puts increase cash balance, hopefully it’s now clear they are subject to MR limitations regarding max quantity with direct implications for risk.

Initial MR for long options is 100% of the purchase price. Cash balance decreases upon purchase and no maintenance MR subsequently applies.

As a reminder, synthetic long stock (SLS) is a combination of long call(s) and short put(s) at the same strike [price].

That light at the tunnel is getting quite bright!

*–MR is not to be confused with margin loan (“debit balance” in [4]) that occurs when cash balance goes negative.