Black Swan - Account blow up - Margin Call (Options Trading)

beastwork

Newbie
8 2
Greetings,

I've searched and searched but I can't find any clear concise information on what exactly happens to accounts when the market experiences a crash. I see many people mentioning how a "black swan" event can decimate an account but no one offers any specifics of how that happens exactly. Obviously I am a newbie, but this is something that makes me really uncomfortable about trading options.

Specific questions that I would like help on (hopefully you can humor my followup questions as well :)):

1. If I am short put spreads during a crash is it necessary to have enough cash in my account to buy all of the stocks associated with my contracts? What happens to a $100,000 account if my short puts are exercised at a $120,000 for example?

2. If I have a $100,000 account and limit the risk of each trade to 1% of total capital and never risk more than 35% of my portfolio am I creating a reasonable safety net for black swan events? I realize that a substantial amount of money could be lost, but would me account be destroyed?

3. If I am holding credit spreads and volatility sky rockets can't I just hold the contracts through expiration and eat the spread difference loss. Or will such an event trigger a margin call from my brokerage?


Sorry for the long windedness but these are questions that I just haven't seen asked or addressed. Any help would be much appreciated. If my questions are confusing please let me know and I'll do my best to rephrase.

Marc
 

lloydbee

Well-known member
275 17
When I was relatively new I had one live account that was small, I cant remember exact trade details without looking them up but I think it was about a $5'000 account or just under and I was caught with an aftermarket fill on a position that I forgot was on and it went immediately ITM by .02 or so and I became short around $320'000 worth of stock.

I was lent the money by my broker of course and on opening the next day the markets gapped up, as the short position became around -$4500 loss I received an email saying they were monitoring my position and were about to close out the trade if I did not take action.

I closed the trade less than 10 minutes later with a 100% blowup, I owed the broker about a further $100 or so. Had it gapped down I would have made some nice profit, but Murphys law slapped me in the face that trade and lesson learnt. So basically you will run with the assigned position until your full capital is at stake of being blown up.

Some people sell naked Puts for example and if they are assigned they then hold the stock hoping for a small rise then sell the shares off as a profit. This works ok as long as you watch your position size. It's a risky way to trade, but still a valid one for some people.

3. As long as the position expires OTM volatility can spike as much as it wants and no loss will happen at expiration.
 
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beastwork

Newbie
8 2
So to parapharase - If I am able to avoid having the stocks "put to me" I will not face the risk of being blown up. Once my short contracts are in the money the brokerage assumes that the options will be exercised. At that point I have to close the position. Incurring the cost of any volume expansion and any resulting losses associated with the underlying stock. But that doesn't necessarily result in a blown up account, correct? Is that about right?

Was your mistake here that you risked too much of the $5,000?

It's a relief to know that volatility can rapidly expand without triggering a margin call as long as my options remain out of the money.
 

lloydbee

Well-known member
275 17
Yes, as long as you close the short leg you are ok. If any trade goes ITM even .01 you WILL be assigned 100% and then you have a 50/50 to either profit from the stock position OR suffer a loss. If your short leg is ITM it makes no difference about you holding it and you can close a short leg at any time right up to the expiration bell.

Yes, my mistake was I was filled on an order way too large for my account.
 

NVP

Legendary member
37,470 1,962
listen dude..........when the sh*t hits the fan all bets are off and don't bank on brokers or anyone honouring positions .............read about historical market crashes and the defaults that occur with everyone refusing to payout

take for example the promise of the uk government to honour the first £80k of cash held in any approved institution (banks , etc etc)

really ?.......think correlation .....its what the quants didn't really figure out right when they packaged up all the clever debt derivatives in the 2000's ...........they figured that if "a" went tits up then "b" would be ok .........because they were relatively non correlated ..........come the big wave in this connected global economy EVERY market is relatively well correlated ........(crash)

so I take things like the £80k promise at face value.....because if everyone goes down then who bails out the government ?

N
 
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CostaKapo

Active member
164 12
I will repost this:

I've had three emails in the past month on people being assigned on positions and receiving margin calls, and generally not knowing what happened. I advise everyone to completely research and become familiar with the exercise/assignment aspect of option trading. If you don't you can find your entire account blown out over a weekend.

Assignments occur in two basic varieties. First, on expiration Friday (or Thursday or Wednsday depending on the instrument your trading, but most commonly on Friday). If you have a position that is .01 in the money, or more, you WILL be assigned. For instance, if you have a 100 Call on stock XYZ that expires today, and XYZ closes (AFTER HOURS) at 100.01, you will find that you own, sometime Saturday, 100 shares of XYZ that you paid $100/share for.

Now this option might have only cost you $100 or so. But all of a sudden, due to the inherent multiplier in options, you are now out of pocket $10,000.00. What if you're account only had $5,000.00 in it? Well, you are going to get both (a) a Regulation T Notice and (B) margin call from your broker. First thing Monday morning, your broker will automatically liquidate the position. What if there is adverse news over the weekend and the opening price is only $80? Well you just lost $2,000.0 -- in a $5,000.00 account. In other words, that $100 option just cost you 40% of your entire account. This happens.

What if you had "hedged" the position though, and had a vertical call spread? For instance, you might have bought the $100/$105 spread on XYZ. Well if XYZ closes anywhere above $105 you are ok because BOTH positions will be auto-exercised. This SOMETIMES results in a margin call as well -- but don't worry. Option clear throughout the day on Saturday and your account will frequenltly show one position and the other not exercised yet. By Sunday morning it will be fixed. By way of example, I had a very large position (for me) (20 contracts) in the LNKD 92.5/95 vertical call before earnings. Well earnings did what they were supposed to and LNKD jumped to 104. Well Saturday morning, all of a sudden, I was SHORT 2000 shares of LNKD and had received roughly $190K in cash into my account. This sends off all kinds of margin alerts. I got an email, a call, and another call. Ignore them, they're idiots. The 92.5 side simply hadn't cleared yet. Three hours later the other option cleared, buying the shorts back at 92.5. Then Sunday morning, your account statment will reflect that all trades happened at the same time.

HOWEVER, what if, on that 100/105 spread, XYZ closes at 103 on Friday? Well, guess what, you'll be assigned on the 100 position, the 105 will expire worthless, and now your back in margin call.

MORAL OF THE STORY:

DONT EVER LET YOURSELF BE ASSIGNED ON A SPREAD THATS NOT FAR IN THE MONEY ON BOTH LEGS.

What if, on Friday, the price of XYZ was at $106 at close? You better have closed the spread, because of after hours trading. The price of XYZ can move after hours -- but you can't get out of the options. So if the market closes at 106, and you say good, both legs will clear and I won't pay commissions (or pay less commissions) and get a huge tax break, you could be wrong, as in afterhours the market might go back to $104.98. Then you're screwed, only the 100 option gets exercised and you go into margin call. I'm convinced when your near a strike the market makers manipulate the after hours markets to have this happen.

Of course if you have enough cash in your account, you won't get margin called -- you're risk profile will just be largely out of whack.

And this isn't to say you can't have a big benefit from this. My single most profitable trade EVER occured on a spread that was $.50 above the line, I didn't close it, and then in after hours the price dropped. So I got assigned long on the lower strike. Well, that weekend there was big news involving the company and the price jumped 15% the next morning. In that case, here's what happens -- I own the 100 (long) /105 (short) vertical. After hours, the price is $104.92. Well that spread was worth $4.85 at close on 20 contracts, or $9,700. Well, Satruday I'm now the proud owner of 2,000 shares bought at $100.00 each, for a net cost of $200,000 -- oops. Margin call, broker call, broker email, ect. Well they inform me the trade will immediately close at open on Monday. Well the price jumped, and the position was closed, at $240,000.00. My original investment of $8,500.00, that I didn't want to close at $9,700.00, netted me $40,000.00, or roughly a 470% return. BUT, what if the price had gone down 20%? Well I would be owing my broker money and have completely blown out my account.

If you have ANY questions on this, please let me know.

Now SITUATION TWO -- and you will, sooner or later, enounter this. Let's say we have that same 100(long)/105 (short) spread on XYZ. Only we own the September spread and today (Friday) XYZ closes at 103. No bigger. UNLESS someone exercises their 100 spread. American style options can be exercised at anytime. Why would this happen with time value? Who knows, most likely someone needed to unwind a position, hedge something, take profits, any number of things realy.

Well if you had a 10 contract position, on Saturday your account is now down $100,000.00 in cash and you won 1,000 shares of XYZ. You will again go into margin call. However, whie this is a headache and you will have to deal with your broker, you don't need to panic because the position is still hedged. You can certainly still lose money -- but only up to the 105 line.

What happens? Well your broker will force you to exit the position Monday morning at the open. If you BEG and wheedle, the broker might let you close the position yourself, so you can close at the mid point instead of just a market order. They should let you do this because the position is still hedged, but you are technically in a Reg T violation, so they won't let you hold it for long. Monday you'll have to sell your shares and buy back the short calls. This should be, at worst, a break even situation because of the time value left in the short calls. However, markets fluctutae and you might have to sell your stock at something like 104 and by the time you exit the short calls its up to 105 (or you get a bad fill price) so you give back some.

When this happens, take your lumps and move on. I have this happen about once a quarter and my worse loss was 4%. There's nothing you can do to protect against this. You are hedged, and you won't blow your account out, but it does suck.
From http://steadyoptions.com/
 
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0007

Senior member
2,369 653
listen dude..........when the sh*t hits the fan all bets are off and don't bank on brokers or anyone honouring positions .............read about historical market crashes and the defaults that occur with everyone refusing to payout

take for example the promise of the uk government to honour the first £80k of cash held in any approved institution (banks , etc etc)

really ?.......think correlation .....its what the quants didn't really figure out right when they packaged up all the clever debt derivatives in the 2000's ...........they figured that if "a" went tits up then "b" would be ok .........because they were relatively non correlated ..........come the big wave in this connected global economy EVERY market is relatively well correlated ........(crash)

so I take things like the £80k promise at face value.....because if everyone goes down then who bails out the government ?

N

You would of course get your £80k back but what it would be worth – who knows ? ............
 
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