When trading undefined risk option strategies such as strangles and straddles, you might find yourself in a position where you need to free up trading margin in cash. In this video, I'll walk through the three ways you can quickly and easily free up capital in your account.
In this video, we're going to talk about how you can free up trading margin and cash in your account. Now, just to be totally clear, what this is mainly for are people who are trading undefined risk trades.
So, these are going to be your straddles and your strangles or any short options that you have. Short puts, short calls. Before we dive in here, again it's important that you have to remember that we should never have our account fully invested and should always leave cash available for "Margin Expansion."
Now, we talk about this a lot in this course, and that's leaving somewhere between 40 and 50% of your account in cash so that you always have money available to make adjustments, enter new trades or even just handle the impact of "Margin Expansion."
Now, during times of high implied volatility, the margin can expand four to five times what the initial margin requirement on a trade might have been.
So, this means that an initial trade requiring $1000 of margin might now require $4000 or more for the same position. Now, this can happen overnight as the markets get more volatile. Volatility goes up, margin expands.
The stock that you're trading, or ETF that you're trading does not necessarily have to move against you for the broker to require that you now have to hold more margin to cover that position because of the risk in the market.
We see this all the time actually in commodities. Commodity trading is notorious for having the brokers increase and jack up the margin requirements, seemingly overnight. A great example of this historically is the Brexit vote.
Right before the Brexit vote, a little while ago, most brokers came out and said look, "All margin requirements are going to be higher across the board," even though nothing had happened between the time that they did that and the vote happened.
So, nothing had happened. They were just preparing for something bad to happen. Required all people to increase their margin requirements and hold bigger cash, available reserves.
So, again, for full disclosure, when implied volatility goes higher, when market volatility goes higher, that position will get a higher credit if you enter a new position. But the margin requirement will be higher for those.
So, how do we reduce margin requirements either on the onset of a trade or subsequently after a trade is already working on our account to free up cash? And we'll go through two different examples here so you guys can see how we would do it on our account.
There are three ways that you can do this, and this is what I want to cover here in today's video. The reducing margin requirements can be done in these three ways.
One: You convert undefined risk trades into their defined risk positions.
So, that would mean converting any straddles or strangles that you have into an iron condor or an iron butterfly. You're taking these undefined risk positions that are holding a lot of margins and converting them to defined risk.
Which caps the margin that needs to be held by the broker because they know exactly how much you can lose on these positions.
The second way that you can do it is you can exit positions that are profitable and tying up funds that could be used elsewhere.
I often see this a lot when I do coaching with people who are running into margin issues. We end up just taking some of these trades off that are profitable, even thought they're marginally profitable.
They just end up tying a lot of capital, and we could deploy the money somewhere better else. So, if you have trades that are profitable, but you're holding them for the next 30 days because you're hoping that you just get all of the money out of the position.
So your squeezing even the last drop of premium out of it. It might not be the best of money to hold that position for 30 days because it's already profitable and because it's just holding a lot of margins.
The third way that you can do this, and this kind of goes with number one, is you can go out and buy cheap long out of the money options in your biggest holdings to cut "tail-risk."
Additionally, if you're using a portfolio margin account, which is going to look at the whole portfolio risk, you can use any of the bench-mark indexes as hedges for the whole portfolio.
And buy these cheap out of the money options and reduce or cut tail-risk. Now, the key with doing this is that you've got to go far enough out that it makes it cheap but not far enough out that it's kind of a non-factor for the broker. Right?
Most brokers are calculating margin on about a two and a half to three percent standard or three standard deviation level. So, if you go further than that, even though it might be cheap, the brokers may not even be counting anything beyond that point as being needed to be covered anyways.
So, it's just spinning your wheels and wasting time here. So, let's jump on over to our think or swim platform. I want to kind of go through a way you can do it right now and so, at the time that we're doing this video SNPs insanely high.
Maybe when I do this video later on I can publicly say I think the market's way too high and we're definitely due for a correction at some point. Whether it happens in 2017 or 18, I don't know. But it's insanely high right now, and volatility is low.
The VIX is insanely low, and that means that margin requirements across the board are not that high. They're not as high as they would be if the VIX were at 20 or 25 etc.
But what we see is if we go in here, and we start looking at potentially doing a trade in the SNP, and I'm just doing a trade 50 days out a regular, standard, strangle, the 15 deltas on each end, so very, very systematic, I get a credit of about $150.
Now, when I hot confirm and send, you can see that the margin or buying power requirement here is about $3900. So, that's pretty significant obviously for a stock like this.
Now, what you can do is you can convert this into a risk to find counterparts. So, if you don't ave the ability to handle another $3900 position, then you can convert this. Right?
So, you can go ahead and let's say we buy options, let's say $10 out on either end. So, we sold the 247 calls. We're going to buy the 257 calls. We sold the 226 puts, and we're going to buy the 216 puts.
So, we are going to cut back on our credit from $150 down to about 103. So, without a doubt, we cut down the credit that we received because we did this risk define, but you'll notice when I do confirm and send here that we cut the margin as well. Dramatically from about $3900 down to about just 900 bucks.
So, in this case, it might be worth doing this type of trade, even though you might have the capital to do the bigger trade it's just not worth it maybe to hold that much margin in your account. Still both high probabilities trades.
Still generally are going to win at the same pace but in this case, you could almost do two or three of these contracts before you even come close to doing how much margin that initial position held.
So, if I even do three of these contracts, I collect way more money overall, not a per contract basis, but overall. And I have less margin that's required than doing the original one strangle.
Now, when you look at this trade again, if you have the original strangle and you think about it logically, if you have the original strangle that's already working in your account, then what you can do is you can come back in here and subsequently buy these long legs and then that will reduce the margin requirement immediately.
So, if you're looking at your positions right now and you think to yourself, "Okay, I've got some positions that are holding up or tying up a lot of margins," great come back in here and reduce some of that margin requirement by buying these long options.
One of the ways that you can do this is by looking at your "buying power effect" inside of your account. So, on the right-hand side here you can see our FXE that we have. We've got a bunch of iron butterflies in here.
So, our buying power is fixed at $3200, for all of these, but this is where you would see if your buying power is fluctuating and moving.
So, if you have something in your account that has a lot of buying power effect here, that's how much margin the broker is allocating in your account towards this position. That might be something that you want to start looking at and adjusting and mitigating.
So, again, XRT is another one that we've got a bunch of positions in. We're about $4600 in margin there. So, still, well within our thresholds for where we want to be but you can see just exactly where that buying power effect comes into play.
As far as the overall portfolio, one of the things that I always look at in reducing margin requirement is this long-tail risk. So, this is what I talk about all the time, and you can see we've done it here with some of the stuff that we've done in our portfolio.
But when we scale down our portfolio we like to always have this even distribution, or a flat curve, or rounded normal distribution curve over the market.
So, the market right now is trading about 238 and even still where the markets trading we still make money on our overall portfolio, for this month.
So some positions might make a little bit of money, some positions might lose but as long as the SNPs stays between 245 and about 220, we're going to make money on our portfolio.
But notice what I've done is I've cut the tail-risk on our portfolio by buying long options that are out of the money on a couple of different securities. So, we just use these different securities to cut this tail-risk.
This is what the brokers are concerned about is a big move in either direction, two, three standard deviation move, and that hurting your portfolio. So, by buying these cheap options far out of the money takes maybe $10, $20 or so in some cases.
You end up moving this portfolio curve and re-shifting it so that if there's a massive, massive sell off, not only do we not lose as much money but we also start to gain back money because of these long options that are cheap.
So, this is a really good strategy, and hopefully, this is a good visualization of how you should be thinking about this. Now I'm not saying you do this all the time, especially if you have all risk to fund positions.
You don't need to do this, but if you are trading in an account that's a little bit larger, and you start doing more straddles and strangles, this might be a really good options to go out here pretty far and start buying these long-leg options far out from where the market is.
So, in the case of ... if you go to DIA or something like that, you could go far out and buy these long options that are far out so that they give you cheap, effective protection. So, in the case of DIA, DIA is trading at 210 right now which is the Dow Jones.
I mean you could realistically go out to somewhere around 200. You can see we're down at about 202 etc. So, you can go out to this level here, ten bucks, $9, $8, there's good volume in liquidity out here, and it's not something you're going to win on, but it's protection.
It's lottery protection against a huge, huge move in the market lower. So, hopefully, that makes sense. Hopefully, that helps out. Hopefully, you guys enjoyed this video.
If you have any comments or questions or feedback, please let me know. Ask them in the comments section right below.
Until next time, happy trading.