Position limits in options trading place an upper limit on the number of contracts which an investor or combined group of investors may hold for a specific security. By placing constraints on the number of contracts and investing party could hold, position limits ensure fairness in the options market by restricting any one investor’s degree of control and cornering the market.
This position limit varies depending on the trading activity and volatility of the underlying stock and is set by the exchange on which the options are traded. The most heavily traded stocks with a large number of shares outstanding have position limits of 250,000 contracts. Smaller stocks have position limits ranging from as low as 5,000 contracts to 200,000 contracts. The exchange on which these options are traded decide the limit and announce it from time to time.
Most of the limits are set as 13,500, 22,500, 31,500, 60,000 or 75,000 contracts.
To understand position limits we first understand that long calls and short puts are on the same side of the market which is bullish side. Similarly, short calls and long puts are on the same side of the market which is bearish side.
Let’s say that exchange decides that 75,000 contracts is the limit on stock AYZ. This limit is valid for both sides of the market. This means an investor cannot have more than 75,000 contracts on one side of the market which could be either bullish side or bearish side.
This means an investor cannot have 40,000 long calls and 40,000 short puts in the same stock as the total number of contracts will be 80,000 on the bullish side.
The same is true for the bearish side of the market. An investor cannot have 40,000 short calls (bearish position) and 40,000 long puts (bearish position) in the same stock as it will be 80,000 contracts on the same side of the market which is bearish.
However, an investor can have 75,000 long calls (bullish) and 75,000 long puts (bearish position) in the same stock as he is not violating the limit of 75,000 contracts on either side of the market.
He can also have 75,000 short calls (bearish position) and 75,000 short puts (bullish position) in the same stock as he is not violating the limit of 75,000 contracts on either side of the market.
If an institution is managing its clients’ positions then this limit applies in total and not on individual client’s basis.
For further details you can visit the website of Options Clearing Corporation and read further to enrich your knowledge of options trading.