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Let's say there is a stock of ABC currently at $8, and I sell a (naked) call option on it, with a strike price of $10 and expiration in two months. Suppose my broker lets me do this if I have 50% of the stock value in my margin account - in this case $4.

Now what happens if for some reason the stock price begins shooting up rapidly (in a span of few hours) from $8 to, say, $30? What can my broker do to prevent liability?

  1. It can't force me to buy the stock to cover the position, because I only have $4 in the margin account and the stock price is now $30.

  2. It can't buy back the call option contract, because it is now worth at least $30-$10 = $20, which is still more than the $4 I have.

But if it doesn't do any of the above, then at the end of the day, who will pay the holder of the call option when he attempts to exercise it?

  • What you're describing is a covered call, not a naked call. The position value (stock + call) will stabilize around $10, even if the stock is at $30. The broker won't do anything. – Alex R Apr 27 '18 at 23:43
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The broker would give you a margin call and get you to deposit more funds into your account. They wouldn't wait for the stock price to reach $30, but would take this action much earlier.

More over it is very unrealistic for any stock to go up 275% over a few hours, and if the stock was this volatile the broker would be asking for a higher margin to start with.

What I am really worried about is that if there were any situation like this you are not considering what you would do as part of your risk management strategy. Before writing the option you should already have an exit point at which you would buy back the option to limit your losses.

  • I'm a frequent option trader but at a different level, never sold naked calls or puts. In the case of a buyout or some extraordinary event that doubles the stock price, does the seller have the normal time to cover the margin call or will the broker cut their potential loss immediately? – JoeTaxpayer Nov 4 '13 at 22:08
  • @JoeTaxpayer - I can just tell you from my experience in selling naked puts/calls and with my broker. The broker has an initial margin position requirement to open the position, if the price moves against me on a particular day (past the initial margin requirement) the broker gives me until 2pm the following day to deposit the funds required for the additional margin. – Victor Nov 4 '13 at 22:30
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If the underlying is currently moving as aggressively as stated, the broker would immediately forcibly close positions to maintain margin. What securities are in fact closed depends upon the internal algorithms.

If the equity in the account remains negative after closing all positions if necessary, the owner of the account shall owe the broker the balance. The broker will close the account and commence collections if the owner of the account does not pay the balance quickly.

Sometimes, brokers will impose higher margin requirements than mandated to prevent the above eventuality.

Brokers frequently close positions that violate internal or external margin requirements as soon as they are breached.

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    Agreed: my broker uses different margin requirements for different issues; I've seen the same at other brokers. For example, for some volatile stocks the margin requirement is 100%, for others 50%; the maintenance requirement on most stocks is usually 25% but higher for more volatile issues. – AndrewS Jul 17 '14 at 18:45
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Yes, it can buy back the call, but much before stock hits the $30 mark.

Let us say you got 1$ from selling the call. So the total money in your account is 4$ + 1 $ = 5 $.

When stock hits 10$ (your strike), the maintenance margin is 5$. As soon as stock goes past 10, your maintenance margin is violated. So broker will buy back your call (at least IB does that, it does not wait for a margin call).

Now if the stock gapped up from 8 to 30,then yes, broker will buy it back at 30, so your account will have a negative balance. Assume the call cost 20$ when stock hit 30, your balance is: 5 - (30-10) = -15.

Depending on broker, I suppose they will ask you to bring your account balance back up to positive. If they don't do that, they risk going out of business.

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