Letter of Guarantee
A letter of guarantee is a document a bank issues to a brokerage firm confirming that a customer actually owns shares of a particular stock, and promising that the bank will deliver those shares if needed. It comes up specifically around options trading, when someone has sold (written) a call option.
Here is why that matters. When you sell a call option, you are promising to deliver 100 shares per contract to the buyer if they exercise their right to buy at the agreed price. If you already own those shares and they are sitting in an account the bank can verify, the bank can vouch for you instead of your broker having to see the shares sitting in your brokerage account. The letter effectively says "we hold this customer's stock, and if their call gets assigned, we will make sure the shares get delivered." This lets the written call be treated as a covered call, meaning it is backed by actual stock, rather than a naked call, where the seller has no shares and is exposed to potentially unlimited losses if the stock price rises.
The nuance that trips people up is that this is a somewhat old-fashioned mechanism, tied to a time when shares might be held at a bank or custodian separate from the brokerage, rather than consolidated in one account. Not every brokerage accepts letters of guarantee as proof of coverage; many now expect stock to sit directly in the account being used to trade the option. There is also a second, unrelated use of the same term inside options clearing: a letter issued by a clearing member firm to the Options Clearing Corporation guaranteeing trades made by a specific trader or broker on the exchange floor. This is an internal, institutional mechanic rather than something a retail trader would encounter directly.
Because both the retail and clearing-house versions involve specific institutional guarantees and acceptance practices, a beginner should treat the exact mechanics, and which firms still use this method, as something to confirm with a current broker rather than assume from an old textbook definition.
This term depends on a rule or threshold that changes over time, so no specific figure is quoted here. Confirm with a current broker or the OCC whether letters of guarantee are still an accepted mechanism for establishing a covered call position, and whether specific brokerages still honor them versus requiring shares held directly in the trading account. Also verify current OCC/clearing member practices regarding letters of guarantee for floor trader or broker trades, as clearing mechanics and acceptance policies can change over time.
A day trader who writes calls needs to know whether their position is genuinely "covered" or effectively naked, since that determines margin requirements and real risk exposure if assigned; a letter of guarantee is one legacy path to proving coverage without moving shares into the brokerage account itself.
Suppose a trader holds 100 shares of a stock at a bank's custody account, not at their brokerage. They want to sell a covered call against those shares through their broker. Instead of transferring the shares, the bank sends the brokerage a letter of guarantee stating it holds the 100 shares and will deliver them if the call is assigned. The brokerage then treats the written call as covered rather than naked, which typically means lower margin requirements than an uncovered position would carry.
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