This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
Options margin and leverage are the two sides of the same coin. The margin is the collateral the broker requires to hold an option position, and the leverage is the return the position produces per unit of margin. The seller of an option uses the margin to support the position, and the return on the margin is the seller's return on capital.
The buyer of an option does not use margin (the buyer has paid the premium in full), but the buyer still benefits from leverage, because the option's potential return is a multiple of the premium. The buyer's leverage is a function of the option's delta and the premium's cost, not of the broker's margin.
The seller's leverage
The option seller's leverage is the notional exposure divided by the margin requirement. A seller who sells a put option on a €100 stock with a €95 strike collects a €2 premium and posts €1,700 in margin. The notional exposure is €9,500 (the value of the shares at the strike price). The leverage is €9,500 / €1,700 = 5.6×.
The seller's leverage is a function of the option's strike, the stock's volatility, and the broker's margin model. A deep out-of-the-money option (€70 strike on a €100 stock) has a lower margin and a higher leverage, because the probability of the option being exercised is low. A near-the-money option (€95 strike on a €100 stock) has a higher margin and a lower leverage.
The buyer's leverage
The option buyer's leverage is the stock's return divided by the option's return. A buyer who pays €3 for a call option on a €100 stock with a €110 strike gets 33× leverage on the premium (€100 / €3). The buyer's maximum loss is the premium, and the buyer's potential return is a multiple of the premium.
The buyer's leverage is highest on a short-dated, out-of-the-money option (low premium, high sensitivity to the stock's move) and lowest on a long-dated, in-the-money option (high premium, low sensitivity to the stock's move). The buyer who wants maximum leverage buys a short-dated, out-of-the-money option, with the understanding that the probability of the option being in the money at expiry is low.
The relationship between margin and leverage
The margin and the leverage are inversely related for the seller. A higher margin means lower leverage, and a lower margin means higher leverage. The seller who wants higher leverage must sell options that are far out of the money, with a low probability of exercise, and the seller is taking the risk of a tail event (a large move against the position).
The margin and the leverage are not directly related for the buyer. The buyer's leverage is a function of the premium, not the margin. The buyer who wants higher leverage buys cheaper options (out of the money, short dated), and the buyer is taking the risk of a total loss if the option expires worthless.
The risk-to-reward ratio
The margin determines the seller's risk-to-reward ratio. The seller collects a small premium (the maximum profit) and posts a large margin (the maximum loss). A seller who collects €200 in premium and posts €1,700 in margin has a maximum profit of €200 and a maximum loss of €1,700 (the margin minus the premium). The risk-to-reward ratio is 8.5:1, and the ratio is unfavourable for the seller.
The seller's edge is the probability of the premium expiring worthless. If the seller sells an option that has a 90% probability of expiring out of the money, the expected value is positive, even though the risk-to-reward ratio is unfavourable on each trade. The seller's leverage is the return on the margin over many trades, not the return on each trade.
The leverage that matters
The leverage that matters for the option trader is the return on the margin (for the seller) or the return on the premium (for the buyer) over a series of trades, not the notional leverage on a single trade. A seller who produces a 20% annual return on the margin (the return on the capital) is using the margin efficiently, even if the notional leverage on each trade is 5-10×.
A buyer who produces a positive expected return on the premium (the return on the capital) is using the premium efficiently, even if the buyer wins only 30-40% of the trades. The leverage is a function of the strategy's win rate and the risk-to-reward ratio, not of the option's notional.
Common questions about options margin and leverage
Can I use options margin for any option type? The margin requirement applies to option sellers on all option types (calls, puts, covered calls, spreads). The margin varies by the option type, with naked options requiring the most margin and spreads requiring the least.
Does portfolio margin change the leverage? Yes, portfolio margin allows the seller to use a lower margin for a hedged position, and the lower margin increases the leverage. The PM is available only for professional and high-volume traders.
How does the broker calculate the margin on a short option? The broker uses a formula that considers the option's current value, the underlying's value, and the out-of-the-money amount. The margin is adjusted daily.
Related resources
Where to start
If you are evaluating options for margin and leverage, the most useful first step is to calculate the margin requirement for your strategy and the expected return on the margin. Our broker comparison lists the option brokers and the margin models, which together tell you what the leverage looks like before you sell your first option.