Margin Relief on Cash-Settled Index Options
What is Margin Relief?
Margin Relief on Cboe's Cash-Settled Index options provide the potential for greater capital efficiency on overwriting strategies using Cboe Index Options to overwrite long exchange-traded fund (ETF) positions based on the same index.
Benefits
Efficiency
Margin relief enables traders to use cash-settled index options as an efficient trading and hedging tool to manage positions at a potentially lower cost.
Versatility
Cboe's new rule offers margin relief for writing cash-settled index options against ETFs based on the same index.
Potential Tax Benefits
Cboe's suite of index options offer cash-settlement, European-style exercise and potential tax benefits.
How Margin Relief Works
Cboe's rule offers improved margin treatment for writing, or selling, a cash-settled index option against an ETF that is based on the same index as the index option. In the same way an investor can write an equity call option while holding a long position in the underlying security (i.e., a "covered" call), Cboe's rule change allows for writing of index options in a similar manner.
Call Writing Example
In a margin account, a customer is long SPY ETF and wants to sell an XSP call option against this holding. Even though the index underlying XSP options might not exactly track the SPY ETF and the SPY ETF is not deliverable if the short XSP call is assigned, the customer may receive relief from the short option margin requirement. The total value of the SPY ETF position must equal or exceed the aggregate underlying index value (XSP x 100). Thus, it's possible more than 100 ETF shares would be required. In this trade example, the customer is long 100 SPY ETF@ 448.50 and sells 1 XSP 9/15/2023 460c call@3.50 and the condition pertaining to the total value of the SPY ETF position is met. Initially (provided the short call option is out-of-the-money) no margin would be required on the option. 1
Be sure to check with your brokerage firm to determine if it offers the margin relief and if there are any special house requirements.
*Note: after initially established, margin is required equal to the greater of: 1) the amount, if any, by which the total value of the ETF position is below 100% of the aggregate current underlying index value or 2) the amount, if any, by which the aggregate current underlying index value is above (below) the aggregate exercise price of the call (put) option. If the total value of the ETF position falls below 95% of the aggregate underlying index value, this margin relief will no longer be allowed and an uncovered short option margin requirement will be triggered. Purchase or deposit of additional shares of the SPY ETF to bring the total value up to the aggregate underlying index value could reestablish margin relief.Which Index Options Can I Use for Margin Relief?
Now you can choose which ETF you want to own, and still use index options as your source of yield. You get the best of both worlds! Buy whichever ETF you want which tracks the S&P 500, and then sell whichever index option linked to the S&P 500 is right for you (SPX or XSP). And did you think your only way to harvest yield in emerging markets was to sell EEM calls against your EEM long shares? Think again, now you can utilize MXEF index options! Cboe·s new rule applies to any index call option written against a long position (or any index put option written against a short position) in a non-leveraged index mutual fund or non-leveraged ETF that is based on the same index underlying as the index option and held in the same margin account. To learn more about Cboe·s index options, visit:
Frequently Asked Questions
Click on the questions below to display the answer.
- What is the new rule change and how does it work?
Cboe’s rule offers improved margin treatment for writing, or selling, a cash-settled index option against an ETF that is based on the same index as the index option. The rule applies to any index call or put option (i.e., the “protected” option) written against a position in a non-leveraged index mutual fund or non-leveraged ETF (i.e., the “protection”) held in the same margin account.
- How does the previous margin rule compare to the approved margin rule?
Under the prior framework, there was no margin requirement for a short call that met the definition of “covered”. Given the similar risk/return profiles of writing an index call option (e.g., XSP) against a long ETF position (e.g., SPY) and writing a covered call, Cboe’s rule treats these index options as protected for margin purposes, rather than uncovered and subject to a short option margin requirement.
- What is Cboe’s rationale for implementing this new margin rule?
Cboe is committed to advocating for smart and efficient market structure enhancements that continually enhance the trading experience of our customers. We expect this rule change will help broaden the utility of index options and make them more readily accessible to investors who are seeking an alternative to ETF options to manage their long ETF positions. The rule provides an additional options strategy to investors, allowing them to utilize cash-settled index options at potentially lower cost than is possible under the current margin requirement – ultimately creating greater capital efficiencies and trading flexibility. FINRA recently adopted a similar margin relief rule which conforms to Cboe’s rule.
- What are its benefits to customers?
We believe our margin relief rule will help reduce operational costs for customers that use the protected options strategy while providing an effective safeguard against the risk of short option positions:
Comparison of Index Options vs. Other Instruments
- In the same way an investor can write a stock call option while holding a long position in the underlying security, Cboe’s rule change allows for writing of index options in a similar manner. An investor, for instance, could write a call option on the Mini S&P 500 Index option (XSP) while having a long position in a corresponding ETF such as the iShares Core S&P 500 ETF (IVV), SPDR® S&P 500® ETF Trust (SPY), or Vanguard S&P 500 ETF (VOO) to enhance returns on their ETF.
- XSP calls match many of the features found with IVV, SPY and VOO options (i.e., similar contract size (notional value), PM-settlement, and high correlation with SPY), while providing other advantages:
Writing Index Options (e.g., XSP) Writing ETF Options (e.g., IVV, SPY or VOO) Cash Settlement. XSP calls are cash settled. In the event of assignment, a related long position in SPY would not be sold. No disruption to long position in SPY. Physical Settlement. SPY calls are settled with sale (delivery) of the long position in SPY at the exercise price. (Exception: there is a possibility that a FLEX option (if offered) could be customized to have cash settlement.) European Style Exercise. Can be exercised only at expiration. Assignment cannot occur prior to expiration. Facilitates easier management of positions. American Style Exercise. Can be exercised at any time prior to expiration. (Exception: there is a possibility that a FLEX option (if offered) could be customized to have European style exercise.) Potential 60/40 Tax Treatment. XSP options are Section 1256 contracts (IRS). This means gains could be taxed as 60% long term, 40% short term, regardless of holding period. Ordinary Income. Short term gains taxed as ordinary income. - How can I implement the new rule in my trading?
Investors interested in implementing this new rule change in their trading will need their broker to add the functionality to their trading platform.
- Where do I access the related rule filings?
Approved Cboe rule filing: https://www.sec.gov/files/rules/sro/cboe/2023/34-97019.pdf
Approved FINRA rule filing: https://www.sec.gov/files/rules/sro/finra/2024/34-99696.pdf
There are important risks associated with transacting in any of the Cboe Company products or any of the digital assets discussed here. Before engaging in any transactions in those products or digital assets, it is important for market participants to carefully review the disclosures and disclaimers contained at: https://www.cboe.com/us_disclaimers/. Brokerage firms may require customers to post higher margins than any minimum margins specified. © 2024 Cboe Exchange, Inc. All Rights Reserved.