Hey everyone this is Kirk [00:00:01] at, optionalpha.com, and 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 really 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 mean that an initial
trade requiring $1000 of margin might now require $4000 or more for the same position.
Now, this can happen literally 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 are now having
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 in our own account. THere's really 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 basically taking
these undefined risk positions that are holding a lot of margin 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 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 margin.
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
really cheap but not far enough out that it's kind of a non-factor for the broker. Right?
Most brokers are basically 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 really cheap, the brokers may not even be counting anything beyond that
point as being needed to be covered anyways. So, it's just kind of 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 was 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 delta 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 definitely 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 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 margin," great come back
in here and basically 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 actually done it here with some of the stuff that we've done in our own portfolio.
But when we scale down our portfolio we like to always have this even distribution, or
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 generally 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 different securities. So, we just use these
different securities to cut this tail-risk. This is what the brokers are really concerned
about is a big move in either direction, two, three standard deviation move, and that really
hurting your portfolio. So, by buying these cheap options really 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 really 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 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 really far out and buy these long options that are far
out so that they give you really 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 definitely 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.