David Jaffee of BestStockStrategy.com breaks down the pros and cons of using margin when trading.
By understanding the pros and cons of using margin when trading options, you can make a more educated decision on whether you should use margin or not.
The answer will not be the same for every options trader, and you have to decide which choice is best for you.
The Pros of Using Margin When Trading
The first pro of using margin when trading options is that there is no margin interest.
Unlike with stocks, you do not need to pay margin interest when using margin.
The second benefit of using margin is that it provides much greater capital efficiency than not using margin.
If you're not using margin, then you are going to have to use cash-secured options. As a result, the buying power requirements for those trades are going to be significantly higher.
Additionally, because you're not using margin, you might be more tempted to choose more aggressive strike prices. When you're using cash-secured options, you're going to want to collect more premium to offset the buying power reduction.
However, when you're using margin, it will afford you an opportunity to go further out-of-the-money and therefore decrease your risk.
The third benefit of using margin is that it provides you with greater leverage and therefore the possibility of earning greater returns.
The fourth pro of using margin is that it provides you with more flexibility.
It is important to remember that just because you have margin doesn't necessarily mean that you have to use it. You can enable margin on your account, whether it be Regulation T or portfolio margin, and you don't necessarily have to use it.
Simply enabling margin on your account does not mean that you have to use up all of your buying power. You can simply reduce your available buying power by the same amount that you would as if you were trading a cash secured option.
The Cons of Using Regulation T or Portfolio Margin When Trading
The first disadvantage of using margin when trading is that you are incurring greater risk.
Remember that with the possibility of greater returns comes greater risk. Leverage is a double-edged sword, and it cuts both ways.
While you have the possibility of earning higher returns when using margin, you are also incurring more risks.
The second con of enabling margin is that human beings are inherently greedy and self-destructive.
You know yourself best. If you feel that you have a tendency to be a little bit of a gambler or to trade too large, then David Jaffee highly recommends that you do not enable margin on your account
The third disadvantage of margin Is that your account may not allow you to use margin, depending upon the account that you are using and trading. Some retirement accounts, whether it be an IRA or 401k, will not permit you to use margin.
In those situations, oftentimes you can trade vertical put credit spreads, where you sell an option and buy a lower priced put option as protection.
Or if you were trading a call credit spread, you would sell a call option and then buy a higher priced call option as protection.
Should You Enable Margin When Trading Options?
Should you enable margin, whether it be Regulation T or portfolio margin, or should you not enable margin and just trade cash-secured puts or cash-secured call options?
David Jaffee recommends enabling margin because it is your choice whether you actually utilize that margin and enabling margin provides you with more flexibility.
As long as you show discipline and patience, you can simply reduce your available buying power by the amount that your account would be reduced If you were trading cash-secured options.
Additionally, David Jaffee believes that by not enabling margins, you are encouraging yourself to be more aggressive with your strike selection, whether that be trading straddles or trading at-the-money options.
Instead, David Jaffee recommends that you trade out-of-the-money options and collect slightly less premium, but also significantly increase your win rate when trading options.
One of the best ways to do this is by using margin because that will reduce your buying power reduction, and therefore enable you to trade more opportunities and collect more premium.
Learn more about using margin when trading by visiting BestStockStrategy.com. Enter in your email address and receive over $400 of valuable free options trading materials.