What is an Option Margin?

M. McGee

Basically, an option margin is when an investor purchases the right to potentially transact on an asset without paying the full amount owed for that right. Since option may be sold and then resold, it is possible for a significant amount of money to be tied up in the potential of a transaction. When buying said option on margin, many people beyond the actual purchasers have stake in the sale.

Businessman with a briefcase
Businessman with a briefcase

In order to understand what an option margin is, it is necessary to look at the two parts individually. An option gives an investor the choice of buying or selling a particular asset by a specific time. The value of an option is derived from the value of the asset it applies to. When the time on the option expires, it is worthless.

While this option is simply the potential to act on an asset, it does involve real money. The option is purchased by an individual, and a contract specifying who may do what, when the option expires and the price considerations to account for is signed by the involved parties. Options are a risky business, as prices may change or sellers may back out. On the other hand, if they work out, an investor has any early lock on a potentially valuable asset.

A margin is an amount of collateral an investor needs to put down in order to cover a portion of the risk of a creditor. In many cases, an investor will only put down a percentage of the actual cost of a purchase; the broker or a third party covers the rest. The other parties essentially loan money to the investor, and as the asset price goes up and down, the margin fluctuates with it.

Many investors use other securities as their margin, some of which may also have been purchased on margin. This can quickly snowball into a very bad situation if one asset loses money. This will cause anything backed on it to lose its margin. The margin holder will ask the investor to bring up the margins to their required level, or the stock will be sold to cover the loss.

This investment web makes an option margin even riskier than normal. An option is centered on the potential of something happening, and a margin is debt spread out to many people. If the option falls through, the margin will drop, and the creditors will ask for money to cover it. Since the option margin didn’t generate any money, the investor is left with a debt and nothing to show for it.

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