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I'm looking to buy puts for short-term option trading. My time horizon is a week to two weeks at most. I only ever trade the options - I never hold to expiration. When I attempt to buy a put, I get an error saying that I don't hold the underlying assets required.

Since I'm buying the put I don't have an obligation to sell and will never be assigned but I understand that if the option expires ITM, my brokerage firm will exercise the put automatically for me, thus throwing me short on the stock. I don't have a margin account and don't really want one.

But then for a single contract with a $100 strike, that's $10,000 right there for the underlying on one put. My average and preferred order price hovers around 1-2k though - these are just bought calls.

Is it common to not be able to buy puts without owning the underlying? Or could it just be that my option access level isn't high enough.

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    Cf "naked puts"
    – keshlam
    Jun 17, 2016 at 19:08
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    sure, it's an ordinary put (you could say a "naked" put - but it's just an ordinary, everyday trade - 99.9% of trades are like this). Note that, of course, you need a tremendous amount of MARGIN sitting there to do this.
    – Fattie
    Jun 19, 2016 at 1:17
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    @ToniAz - You are correct but unfortunately, once upon a time buyers of options used the expression "Buying naked calls" for the outright buying of calls. This vernacular used by old timers is not only no longer in vogue but it's confusing. As you noted, today, naked means short. FWIW, selling a put would still be naked if you didn't own the underlying. It would be a covered put only if you were short the stock. Ironically, covered has nohing to do with the risk of the combined position. It only means that the option is covered for margin purposes.
    – Bob Baerker
    Sep 17, 2018 at 17:25
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    @ToniAz - (3) is a Cash Secured Short Put. A covered put is synthetically equal to a naked call. You can see the 6 basic positions in the Synthetic Triangle at: brainscape.com/flashcards/… . For an explanation of the covered put (or naked call) see: leavittbrothers.com/education/option_strategies/… . Explaining the last sentence requires more space than a comment allows.
    – Bob Baerker
    Sep 18, 2018 at 0:59
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    Your last sentence also puzzles me (g). Why would you wait for a cheap stock to go up before buying puts on? Do you already own the stock?
    – Bob Baerker
    Sep 18, 2018 at 1:03

4 Answers 4

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Yes, it's completely normal to buy (and sell) puts and other options without holding the underlying.

However, every (US) brokerage I know of only permits this within a margin account. I don't know why...probably a legal reason. You don't actually have to use the margin in a margin account. If you want to trade options, though, you will need a margin account.

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    That might be country specific. I have trading accounts in Germany and Luxembourg, both do not require a margin account. All I need is the money to pay for the Puts (plus transaction fee).
    – Aganju
    Jun 17, 2016 at 19:10
  • I believe the reason for requiring a margin account is to cover the possibility that the holder is unable to square their position prior to exercise at expiry ITM due to circumstances beyond their control. For example, the holder may be in hospital.
    – not-nick
    Jun 17, 2016 at 19:10
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    @NickR. One would assume it's something like that, but holding long positions in options and having access to margin don't seem closely related to me. Those positions should always pay off a non-negative amount, so what's to square?
    – farnsy
    Jun 17, 2016 at 19:15
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    Again, makes sense except in the case of long options. No one will force you to make or take delivery if you hold a put. Right?
    – farnsy
    Jun 17, 2016 at 19:35
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    ITM options are automatically exercised at expiry. It's up to the holder to square their position prior to expiry in order to avoid exercise. See JoeTaxpayer's answer below.
    – not-nick
    Jun 17, 2016 at 20:29
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In the money puts and calls are subject to automatic execution at expiration. Each broker has its own rules and process for this.

For example, I am long a put. The strike is $100. The stock trades at the close, that final friday for $90. I am out to lunch that day. Figuratively, of course. I wake up Saturday and am short 100 shares. I can only be short in a margin account. And similarly, if I own calls, I either need the full value of the stock (i.e. 100*strike price) or a margin account.

I am going to repeat the key point. Each broker has its own process for auto execution. But, yes, you really don't want a deep in the money option to expire with no transaction.

On the flip side, you don't want to wake up Monday to find they were bought out by Apple for $150.

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While buying and selling the put shouldn't require margin, it is only useful if you can exercise it. If you don't already have the stock in your account to exercise it against, the broker would have to lend you the stock (i.e. let you short the stock). To be able to short the stock, you need a margin account.

It is possible to avoid exercising the put by either (1) selling it prior to expiration or (2) issuing a 'contrary exercise instruction' (i.e. telling your broker not to exercise the option).

However these things will not be helpful for you because in the case of (1) you will be subject to the market spread - i.e. the market may not pay as much for the option as it is worth; and in (2) you would be leaving a profitable put option exercise on the table.

This raises the question - why not simply open a margin account?

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In the US, you are permitted to buy options in a Cash Account. No margin is needed since long options are not marginable (other than LEAPs) and must be paid in full with cash. You can also sell cash secured short puts in a Cash Account.

Check with your broker to see what level of option approval you have. Level 1 option approval is for selling covered calls and cash-secured puts. Level 2 option approval is for buying options.

The OCC will automatically exercise any option that is one cent or more ITM at expiration, whether long or short. This is called Exercise by Exception. For equity options, you'll end up with a position in the underlying (index options are cash settled). If you are long the option, it is only ITM by pennies and your commission cost exceeds the salvage value, you can designate to your broker that your long options are not exercised at expiration.

As long as you do nothing in your Cash Account that requires margin then you should have no problems whatsoever. That means either selling your ITM options to close or designating "do not exercise" in order to avoid automatic exercise at expiration.

As xirt noted, you may be cutting off your nose to spite your face by having to close long options that trade below intrinsic value via STC in a Cash Account. You can avoid this haircut and get full value by exercising the option along with the appropriate closing equity transaction if done in a margin account.

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