Haircut

A haircut is what is offered to market makers, a risk based haircut. A haircut is where you are not putting up the notional value of your position but rather the risk capital. Using the word leverage to describe it is rather tricky. Because it can be anywhere from 10 to 1 to 100 to 1. Haircuts usually consist of using the max loss your position would incur today with a 15% up move and 15% down move in a stock. With indexes it’s 10%. This is all you put up. Everyday your haircut changes as the underlying moves. The biggest advantage to haircuts is not the initial leverage, but rather the fact that when you make adjustments to your position, rather than having to put up more capital, you put up less capital. This allows you to trade the underlying at will, trade synthetics, and lay out premium at no cost. When one is long gamma, since there usually is no risk outside of daily decay, the exchange makes you put up a minimum of $25 per contract on equities and 1$ per contract for indexes.

It’s difficult to trade options for a living in a retail account. Not that it’s easy doing it in a professional account either. You need haircut margins unless you’re managing OPM in large amounts. Even then, it’s beneficial to have a haircut account. The real value of a haircut is not in the additional leverage it provides; leverage is a doubled edge sword, but rather in its ability to help you remove risk. In other words, the very opposite of what leverage creates. If you cannot manage risk, you cannot make money trading options. It’s just that risk is what kills every trader. Guys don’t go broke because they have a bad strategy, or they have no edge, or their commissions are too high. They go broke because they can’t manage risk or don’t have the ability to. A haircut allows you to manage risk without the outlay of additional capital. If market makers couldn’t have haircuts on the floor, they could not make markets, end of story.