Margin account question, for vertical option spreads?

Question

I have an account with td ameritrade. I want to get upgraded to level 3 options so that I can create spreads. I want to be able to do bull put spreads and bear call spreads. Td ameritrade said I need to apply for margin also. Why is that? Will I need to use their money? Will I get hit with interest?

Answer 1

Bull put vertical spreads and bear call vertical spreads are both opened for a credit and closed for a debit. The maximum debit is a potential liability which, if you cannot pay, the brokerage must pay. To protect itself, the brokerage requires that you have a margin account so it can issue a margin call if required.

If you keep enough cash in your account to cover the liability you will never need to use their money and you will never be charged interest.

Example:

Assume you sold 20 XYZ $70 calls and sold 20 XYZ $75 calls for a credit of $1.25 per share. If you hold the position until expiration, and the price of XYZ is at least $75 per share at expiration, you will owe $5.00 per share, or $10,000 at expiration. (Since you received $2,500 at the time you opened the spread your loss would only by $3.75 per share, or $7,500.)

If you cannot pay that $10,000 the brokerage must. If you have a margin account they can borrow the money in your name and start charging you interest on it.

There are two other reasons a margin account is required. One is that the SEC requires it. The second is that they will monitor your total margin available to issue a margin call before the options expire if it is clear you are getting into too much trouble with your spread(s).

Answer 2

I have not done bear call spreads or bull put spreads yet.  But thinkorswim.com has what they call "modified margin" that can even be used in cash retirement accounts for any option trades with known risk.

I have done long or covered calls and vertical bull call spreads which do not seem to reserve any cash margin.  And I have done short puts, which reserves enough cash margin to cover the strike price.  A vertical bull put spread would only reserve enough cash margin to cover the spread, since that would be maximum risk.

Fidelity will not even approve me for buying calls yet (except to close a covered call).