Not clear about margin requirements on Shorting Puts

Question

I'm trying to understand how Margin Requirements work when trying to sell a Put Option without having sufficient cash to cover the Option in case it's assigned.
For example, let's say I have $100 worth of equity all paid for (no margin balance) sitting on my account, and no more cash left for use without going into margin territory. I decide to sell a Put (assume at-the-money and a $0 premium for simplicity) that if assigned, would require me to use $100 of margin to buy the underlying.
According to Fidelity, the margin requirement for such a position is as follows:

The higher of the following requirements:

25% of the underlying stock value, minus the out-of-the-money amount, plus the premium

15% of the strike price, plus the premium

Now, let's say my $100 worth of securities plummet to $15. Let's also say the underlying of my Put Option also plummets to $0. Under these circumstances, I would not be required by Fidelity to do anything because my $15 worth of securities is still equal or higher than $0 (25% of the underlying stock at $0) and $15 (15% of the strike price of $100).
This Option is then inevitably exercised, leaving me on the hook for $75 owed to Fidelity ($100 strike - $15 worth of liquidated securities) and absolutely no collateral left for Fidelity to enforce this debt.
So, how did these margin requirement rules really protect Fidelity at all? I am clearly misinterpreting them. Can someone explain where I'm wrong?

AxiomaticNexus · Accepted Answer

The premium change throughout the life of the position is what's being overlooked in the example. If the underlying goes down in price, the option premium will go up, moving the margin requirement up with it.
In the example, still assuming a $0 premium at-the-money option for simplicity, the margin for (a) will be $25 to start and the margin for (b) will be $15. Since (a) is higher, the margin requirement is $25.
If the underlying drops, the premium will increase by at least that much, so the margin for (a) and (b) will both increase as well:
(a) = (25% x underlying) + New Higher Premium
(b) = $15 + New Higher Premium.
By the time the underlying hits $60, (b) would have overtaken (a).
The $100 in equity cannot go down to $15 like in the example, without hitting both (a) and (b) along the way.

Bob Baerker · Answer

Your question is full of unrealistic simplifications, confusing statements, and misinterpretations so I can't begin to address it as asked.  So let's try another approach.
According to Fidelity, the margin requirement for such a position is as follows:

The higher of the following requirements:

(a) 25% of the underlying stock value, minus the out-of-the-money amount, plus the premium

(b) 15% of the strike price, plus the premium

Suppose you sell a $100 put for $6 when XYZ is $100.  The margin requirement for (a) will be $31.  The margin for (b) will be $21.  Since (a) is higher, the margin requirement is $31.
If XYZ drops, the margin for (a) and (b) will increase but (b) will increase faster since the 15% is a fixed number. When XYZ is $60, they'll be the same ($15 plus the significantly higher premium).
The above addresses Fidelity's  margin requirement for the short put.
If your short put is assigned, you'll buy XYZ for $100 for a net cost of $94.  Reg T initial margin is 50% (which is what Fidelity requires) so this position will require $4,700 in cash and/or marginable securities to support the share purchase on margin.
If you lack sufficient margin, Fidelity will close the position.  Different brokers handle liquidation in different ways, depending on whether it's early assignment or it's expiration day.  Either way, the broker closing your position is not good for you because it will likely happen when bid/ask prices are wide, and even wider if it occurs during after hours.

Not clear about margin requirements on Shorting Puts

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