Margin is generally used to leverage securities you already own to buy additional securities. Margin allows you to borrow money from your broker-dealer in order to increase your buying power. Since margin is a loan, you can think of securities you own in your cash account as the collateral for the loan.
Non Margin Buying Power
A margin call occurs when the value of your account drops below the minimum level established by your broker-dealer. To resolve a margin call, you can either deposit more funds into your account or close out (liquidate) some positions in order to reduce your margin requirements.
Alternatively, E*TRADE can sell securities in your account in order to cover your margin deficiency at any time without prior notice. You are also responsible for any shortfall in the account after these sales.
Suppose you want to buy 100 shares of XYZ stock currently trading at $60 per share. In a cash account, this trade would require you to put up the full cost of the trade, or $6,000. By contrast, a margin account allows you to borrow half of the cost of the trade from your broker. In this case, you would put up $3,000 to own $6,000 worth of stock. This activity would also be subject to applicable fees, commissions, and interest. Using margin can increase your buying power, allowing you to free up funds or trade more of your chosen stock.
Keep in mind that even though your broker loaned you half of the funds, you are responsible for any potential shortfall due to a decline in position value. Furthermore, if the price of your stock falls enough, your broker will issue a margin call.
Trading on margin involves specific risks, including the possible loss of more money than you have deposited. A decline in the value of securities that are purchased on margin may require you to provide additional funds to your trading account. In addition, E*TRADE Securities can force the sale of any securities in your account without prior notice if your equity falls below required levels, and you are not entitled to an extension of time in the event of a margin call. When trading on margin, an investor borrows a portion of the funds he/she uses to buy stocks to try to take advantage of opportunities in the market. He/she pays interest on the funds borrowed until the loan is repaid. For each trade made in a margin account, we use all available cash and sweep funds first and then charge the customer the current margin interest rate on the balance of the funds required to fill the order. The minimum equity requirement for a margin account is $2,000. Please read more information regarding the risks of trading on margin.
*For simplicity, this example does not account for the interest you would owe your broker on the $25 margin loan you used to buy this stock. After paying this interest to your broker, your actual return would be slightly less than 100%.
The downside to using margin is that if the stock price decreases, substantial losses can mount quickly. For example, let's say the stock you bought for $50 falls to $15. If you fully paid for the stock, you would lose 70 percent of your money. However, if you bought on margin, you would lose more than 100 percent of your money. In addition to the 100% loss of your $25 initial investment, you would also owe your broker an additional $10 plus the interest on the margin loan.
To open a margin account, your broker will have you sign a margin agreement. The margin agreement may be part of your general brokerage account opening agreement or may be a separate agreement.
The margin agreement states that you must abide by the margin requirements established by the Federal Reserve Board, self-regulatory organizations (SROs) such as FINRA, any applicable securities exchange, and the firm where you have set up your margin account. Be sure to carefully review the agreement before you sign it.
As with most loans, the margin agreement explains the terms and conditions of the margin account. For example, the agreement describes how the interest on the loan is calculated, how you are responsible for repaying the loan, and how the securities you purchase serve as collateral for the loan. Carefully review the agreement to determine what notice, if any, your firm must give you before either selling your securities to collect the money you have borrowed or making any changes to the terms and conditions under which interest is calculated. In general, a firm must provide a customer at least 30-days written notice of changes in the method of computing interest.
But if your firm has a maintenance requirement of 40 percent, you would not have enough equity. The firm would require you to have $4,800 in equity (40 percent of $12,000 = $4,800). Your $4,000 in equity is less than the firm's $4,800 maintenance requirement. As a result, the firm may issue you a "margin call" to deposit additional equity into your account since the equity in your account has fallen $800 below the firm's maintenance requirement.
If your account falls below the firm's maintenance requirement, your firm generally will make a margin call to ask you to deposit more cash or securities into your account. When a margin call occurs you generally cannot purchase any additional securities in your account until you satisfy the margin call requirements. If you are unable to meet the margin call, your firm will sell your securities to increase the equity in your account up to or above the firm's maintenance requirement.
However, your broker may not be required to make a margin call or otherwise tell you that your account has fallen below the firm's maintenance requirement. Your broker may be able to sell your securities at any time without consulting you first. Under most margin agreements, even if your firm offers to give you time to increase the equity in your account, it can sell your securities without waiting for you to meet the margin call.
Like all loans, margin loans charge interest. This interest directly reduces your return on investments, increasing the amount your investment needs to earn to break even. Interest rates can vary substantially between brokerage firms. Remember to carefully consider this expense before opening any margin account.
Instead of charging for individual transactions, some investment accounts charge an asset-based fee (annually, quarterly or monthly) equal to a percentage of the market value of the securities in the account. If you use margin to purchase securities in these accounts, remember that the asset-based fee is typically based on the value of all securities in the account and does not account for the debt used to purchase margin securities.
In addition to purchasing securities, some brokers may allow you to use margin loans for a variety of personal or business financial purposes, such as buying real estate, paying off personal credit, or providing capital. Using margin loans for non-securities purposes DOES NOT change the way these loans work. These loans are still secured by the securities in your margin account and thus subject to the same risks associated with purchasing securities on margin described above. The terms and conditions of these loans vary between brokers and are generally specified in the margin agreement. You should carefully consider the margin risks described above as well as any fees which may be associated with these loans before using them for any non-securities purpose.
Some margin accounts allow the brokerage firm to lend out securities in the account to a third-party, at any time without notice or compensation to the account holder, if the investor has any outstanding margin loan in the account. While shares are lent out, you may lose the voting rights associated with those shares. You will still receive a payment for any dividends related to lent out shares. However, since you are not the official holder of the shares, the payment you receive may be taxed differently. Ask your brokerage firm if its margin accounts allow for securities lending, and if so, to explain how it works and may impact the securities in the account.
This Notice clarifies customer maintenance margin requirements and the application of maintenance loan value for equity securities that do not meet the definition of a margin equity security under Regulation T.1 Firms have until July 1, 2011, to comply with these requirements.
Regulation T stipulates that the initial margin requirement for an equity security is 50 percent of the current market value,2 provided the security meets the definition of a margin equity security. This initial requirement is applied at the time a trade is executed. Once the trade has been executed, FINRA imposes a daily maintenance margin requirement, which for long equity securities is generally 25 percent of the current market value.3 In addition, the current maintenance margin requirement for a short equity security is the greater of: (1) $2.50 per share or 100 percent of the current market value of each short equity security priced at less than $5.00 per share, or (2) $5.00 per share or 30 percent of the current market value of each short equity security priced at $5.00 per share or greater.4 Detailed below are the initial and maintenance margin requirements for non-margin eligible equity securities.
Regulation T permits a long position of a non-margin eligible equity security to be held in a margin account, provided an initial requirement of 100 percent of the current market value is deposited.5
Pursuant to FINRA Rule 4210(f)(8)(A)(ii), FINRA is clarifying that the maintenance margin requirement for a non-margin eligible equity security held long in a Regulation T margin account shall be 100 percent of the current market value. This is consistent with the maintenance margin requirement for a non-margin eligible equity security held in a portfolio margin account.6
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