Liquidations

In a margin account, liquidations are triggered when the account’s margin requirements exceed the available collateral, which leads to two possible types of liquidations: short liquidation and long liquidation. Here’s a breakdown of each:

Short Liquidation

• Trigger: This happens when a trader holds a short options position, and the margin requirement for this position surpasses the collateral available in the account.

• Process: A liquidator bot steps in and takes control of the trader's short position, exchanging it for the collateral in the account.

• Liquidation Price: To mitigate the liquidator's risk, the bot liquidates the short position at a price calculated using an inflated implied volatility, which is set higher than the market price. This ensures that the liquidator is compensated for the risk they are taking on, as short positions can theoretically have unlimited downside.

Long Liquidation

• Trigger: This occurs when a trader has a debit calendar spread and the short leg of the spread expires in the money (ITM), resulting in a negative settlement payout.

• Process: To cover this payout, the liquidator purchases the long leg of the spread for its intrinsic value. This liquidation offsets the negative payout from the short leg.

• Liquidation Price: Intrinsic value of the long option.

In both cases, the goal of the liquidator is to liquidate only enough of the position to restore the margin account to a healthy state, minimizing the impact on the trader while reducing risk to the liquidator. The process does not liquidate the entire position unless it’s absolutely necessary.