Overview
Margin Trading and Investing allows a more experienced account holder to use leverage when buying, selling, and holding margin eligible securities. However, because of the increased risk inherent in using margin leverage, the regulatory authorities and brokerage firms alike have in place rules and risk metrics to better protect the customer and the firm’s financial assets.
What is Margin?
A margin enabled account allows a trader/investor to use their account’s holdings as collateral to borrow additional funds from their broker. Those funds can then be used to purchase additional assets or can even be withdrawn if needed. But with this increased buying power comes increased risk of loss in an adverse market situation. If a client’s assets depreciate to the point in which they can no longer support the margin loan, then that client is issued a margin call, or a direction to either increase the accounts assets by depositing money or securities, or reducing the loan by covering positions held using borrowed money.
Rules Based Margin
Longbridge allows customers to trade on margin using the rules set forth by FINRA Rule 4210 and Regulation T. These rules establish the initial and maintenance requirements for various securities and security types and ensure compliance with industry standards. (Margin Accounts must have equity of $2,000 to utilize margin leverage)
Regulation T requires that customers provide a minimum of 50% of the initial capital required for a new purchase. This means that a purchase of XYZ stock of $10,000 would require $5,000 be provided by the customer and the other $5,000 be borrowed (and subject to interest) from the brokerage firm.
Once this initial margin requirement is satisfactorily met, a minimum maintenance margin requirement is applied. FINRA rules typically require a 25% minimum maintenance margin.
In the above scenario, this means that if your purchase of XYZ stock begins to decline in value, you wouldn’t necessarily have to take action immediately, but have a cushion between the initial requirement of 50% and maintenance requirement of 25%.
For example, see below chart:
- When you initially borrowed $5,000 to buy $10,000 of XYZ stock, your total account value (or net liquidating value) is $5,000, and maintenance margin is $2500.
- If your XYZ stock drops in value, your account value also drops. In the second line, with XYZ worth $8000, you still have an account value exceeding your margin requirement.
- When XYZ stock drops to $6,000, your resulting account value isn’t enough to support the $1,500 required. In that situation, you’d have to either liquidate a portion of your XYZ position or fund your account.
| Scenario | XYZ Stock Value | Margin Debit | Net Account Value | Maintenance Requirement (25%) | Margin Call? |
|---|---|---|---|---|---|
| Initial Purchase | $10,000 | $5,000 | $5,000 | $2,500 | No |
| After Stock Drops to $8,000 | $8,000 | $5,000 | $3,000 | $2,000 | No |
| After Stock Drops to $6,000 | $6,000 | $5,000 | $1,000 | $1,500 | Yes |
To Rectify:
- Option 1: Deposit Funds Add at least $500 in cash to bring your equity (Account Value) up to the $1,500 maintenance requirement.
- Option 2: Liquidate Stock Sell enough XYZ stock to reduce the margin debit or increase equity. For example:
- Selling ~$2,000 worth of XYZ would reduce your position to $4,000.
- Maintenance requirement becomes $1,000 (25% of $4,000), which matches your equity.
Margin Calls
Rules Based Margin accounts issue an assortment of different Margin Calls to customers that are not adequately funded. The big two are REG – T Margin Calls and Maintenance Calls.
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Reg T calls – These are issued when an account holder does not have the required 50% up-front equity for initial purchase of a security. When this type of call is issued, it can typically only be met with funds or margin eligible securities.
- Reg T calls are typically due on settlement, or T+3
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Maintenance calls – These, like in the previous example, occur when an accounts value drops do to adverse market movement. Maintenance calls are more flexible and can be met by depositing funds or securities, or by liquidating positions, or a combination of all three.
- Maintenance Calls are typically due immediately, or T+1. Because of the shorter due date, these types of calls can be more difficult to met with the deposit of securities.
Other Call Types
- Concentration Call – Longbridge may hold a position that is ‘concentrated’ at a higher than minimum margin requirement. Concentration occurs when the majority of an accounts equity is held in only one or a few positions.
- Risk Call – Risk calls are issued in accordance with the brokerage firms risk department to ensure that an account isn’t subjected to emerging or novel market risks. Firms can increase the margin required on any position at any time based on their risk appetite.
- Day Trade Call – Day Trades are trades that are open and closed in the same day, and often allow a greater use of leverage than trades held overnight. More about Day Trade calls will be discussed in the Day Trading section.