Options Forum: Costs and Returns

This column was originally published May 13, 2005 at 4:03 p.m. EDT. It is being republished as a special bonus for TheStreet.com readers.

Steve,

What do you think the margin requirement would be on the butterfly trade you mentioned?

-- Gus

On a long butterfly such as the one described in last week's column, where one is shorting the middle strike, the margin requirement should be equal to the net debit of the position, because the maximum loss of such a position is limited to its cost. In the example provided, that would be $14 for each 1x2x1 spread.

Margin requirements on long option or net debit positions are easy to calculate, but short option, net credit or multileg positions are more complicated and must be taken into consideration before entering a position. Some of the basic rules regarding option margin requirements were discussed in this previous article.

For those too busy to click and read through that past pile of words, the basic formula for calculating margin requirements on short options is as follows:

The margin requirement for selling an uncovered or "naked" option is the greater of 1.) 20% of the stock price plus the put premium less the amount that the put is out of the money; or 2.) 10% of the stock price plus the premium collected.

For out-of-the-money credit spreads, this basically translates into an initial requirement equal to the width, or price difference between the strikes. But as always, requirements can vary depending on brokers, your level of trading or account balance. As we'll see below, the condor position described in Wednesday's column should be considered two offsetting credit spreads with a risk limited to just one side, and therefore not subject to a double margin.