stone wrote:
Machine Ghost, I'm ignorant about options. I don't understand how there could be no counterparty risk unless whenever someone sells a put option promising to say buy a share at $100, they also hand over $100 and that is kept in a safe until the option expires. Is that what is done?
When someone writes an option, the seller has to put up a margin deposit as a fraction of the underlying value. I think that is set by the Federal Reserve's Regulation T and is 20% of the underlying, i.e. 5:1 leverage. Brokerages enforce different levels of option strategy clearance on accountholders with naked, uncovered sales being the most riskiest and stringent. For instance, retirement accounts cannot write naked options, they have to do what is called "cash secured puts" where 100% of the underlying value is in the account in case a written put gets exercised and "put" to you. This is allegedly for safety reasons of the accountholder, not counterparty risk.
So I guess if a brokerage doesn't do their due diligence properly and allows stupid idiots to write options for more than they have in the account for margin or an accountholder gets a margin call when the market drops dramatically who lied about his liquidable assets and net worth, there would be counterparty risk, but that is where the OCC would step in.
In 1987, you had writers simply wiped out who wrote naked options deep out of the money under the stock market. They had to liquidate their own personal assets to clear with the OCC. And this was all back before electronically-enforced margin rules and electronically-enforced due diligence, etc.. Truly a different era and we survived just fine.
The OCC system surely isn't foolproof but its not like the subprime debacle with off exchange transactions in illiquid customizable contracts written by investment banking firms "ripping the faces off muppets". The former is prudent regulation to protect everyone involved, the latter was just blase gaming of the system.
A similar clearing system to OCC exist for stocks, futures, etc.. Its all epheremal B.S. at the end of the day. Hence, the need to hold physical gold.