The Margin Call from Hell

It was just another quiet Friday afternoon. I was letting my call spreads in Netflix (NFLX) run off in the weekly expiration. They were $100 deep in-the-money and I had $1 million in excess margin, so I figured I could just go take a nap.

Then, at exactly 1:30 PM EST, a message highlighted in bright red appeared in my margin balance sheet. I had just received a margin call for $3 million. I got on the phone and called the head of the margin department at my broker.

What I learned shocked me.

It turns out that brokers can raise margin requirements at any time for any reason. They are in business to assure their prosperity, not yours. Their measly 50-cent commission is not worth risking $1 million.

I already knew this and was reminded once again last April. As volatility soared from $15 to $60, I was shedding positions as fast as I could to beat the margin calls I knew were coming.

But there were some finer points that were a revelation.

It turns out that exactly 2 ½ hours before the market closes on expiration days, brokers can impose a new set of margin requirements called the “Predicted Post-Expiry Excess.” This calculation is made by an in-house algorithm that brokers don’t release to the public, and every broker is different.

Brokers will immediately sell any position of yours that they want at market to meet your new margin requirement. And it turns out that options that expire in 2 ½ hours don’t have a lot of liquidity.

My Netflix $5.00 spread could only find a bid of $4.20, so I potentially could lose the entire profit on the trade. I checked my other positions to see what my potential loss was. My $10 Strategy (MSTR) spread could only get a $2.00 bid at market, generating a 60% loss. My Tesla $10 spread, which trades like water, was trading at $9.89, so I quickly sold that, leaving the last 11 cents on the table but meeting my surprise margin requirement.

The “Predicted Post-Expiry Excess” is designed to protect brokers from the following situation, however rare. Let’s say that Netflix is trading at $1,100 and you are long 100 X $990-$1,000 call spreads that are expiring at 4:15 that day. Looks good, doesn’t it? But what if the company makes an announcement or there is a leak at 4:10 PM that causes a catastrophic decline in the shares to, say $995.

In that case, your short position in the $1,000 calls expires worthless, but your 100 X long position expires in-the-money and is exercised into $10,000 shares worth $9.95 million. If you have $9.95 million in cash in your margin account to pay for the shares, that’s fine. If you don’t, the shares you can’t pay for will be sold at market on Monday morning.

But what if you only have $100,000 and the share opens down 2% on Monday morning? In that case, your shares are sold at market, your $100,000 in account equity is completely wiped out, and your broker has to take the loss on the extra $100,000. Your broker could probably recover his lost $100,000 by suing you, but that could take years. The “Predicted Post-Expiry Excess” protects your broker from this possibility.

The only way to avoid a “Predicted Post-Expiry Excess” margin call for sure is to sell them on Thursday, the day before expiration. Then you can usually get $9.95, $9.96, or even $9.98 for a $deep in-the-money $10 spread. Believe it or not, some 57% of current options trading is in one-day or same-day options!

There are a few other reasons brokers can spring surprise margin calls on you.

There is no single “latest” time for a broker to issue a margin call on options expiration day. A broker can issue a margin call at any time, with or without prior warning, if your account equity falls below the firm’s maintenance margin requirements. This is especially true during expiration, when events can rapidly change the value of your positions. The exact timing can depend on multiple factors, but here are the critical moments to be aware of: 

Automatic exercise: For American-style equity options, any contract that is “in-the-money” (ITM) by at least $0.01 at the market’s close (4:00 p.m. ET) will be automatically exercised by the Options Clearing Corporation (OCC).

After-hours assignment: A short option that is “out-of-the-money” (OTM) at the 4:00 p.m. ET close could still move ITM if the underlying stock price changes during after-hours trading. The long option holder can then choose to exercise, which would result in an unexpected assignment for the short option holder.

Overnight position risk: If an options position results in an underlying stock or short stock position, you may receive a margin call on the next trading day if your account has insufficient funds to support the new position. This happens commonly with new or inexperienced traders who don’t have enough capital to cover the purchase of shares upon exercise.

Firm’s discretion: Your brokerage firm has the right to manage its own risk. Your signed margin agreement allows them to sell your securities without warning to cover a margin call if necessary. Many firms may require extra margin on expiration day due to increased volatility and risk. Hence, the “Predicted Post-Expiry Excess” margin call.

I just thought you’d like to know.