Here is Part 1, An Intro to Margin
Quantitrader has a portfolio that uses Margin in the true sense.
Whereas before when we referred to Margin it was to define an account where we could short. Our portfolios, however, did not use margin as most think of leveraged margin. I made a business decision when I started QiT to not use margin.
That changed and QiT ventured into the world of leverage but we want all our members to fully understand what leverage really means. Thus we are doing a 3 part series of what it means to, “use Margin.” If you want to read the first part, click here.
Here we are going to have to explain the basics of margin math.
For some, margin seems complicated because it has its own jargon, and has some requirements that come from the Fed. Yet some jargon is unique to a particular brokerage. The math behind the use of margin is relatively simple. The way we are going to use margin makes it even simpler still.
But, there are some basics that one needs to understand.
Basic Idea behind Margin
The basic idea behind the use of margin is that one borrows some amount of money to purchase a security such as a stock. The rate at which this money is loaned is called the “margin loan rate.” As I’ve mentioned in the previous article, that rate is currently 1.91% at Interactive Brokers. It is significantly higher at other brokerages.
The maximum amount of the loan is governed by the Federal Reserve Board and Regulation T. An investor may borrow up to 50% of the purchase price of a stock. For simplicity in these examples, we are going to be using an initial account size of $1000, and an initial stock price of $10.
So, Regulation T would say that we can buy $2000 worth of stock as follows –
Initial account size is $1000
Loan is $1000
Total dollars is $2000
# of shares @ $10 is 200
Let’s now talk about Leverage
Fully margined, as in the example above, we control $2000 of stock with $1000 of equity. So, the leverage is 2x. It is also important to note, that the investor can put up more cash and borrow less. More about this shortly. Daily interest is accrued and debited daily to the investor’s account.
Much of the trepidation about using margin tends to come from the next topic which is the “maintenance margin.” This is the minimum amount of equity that must be maintained in the account. If the account balance falls below this requirement, a “margin call” can be issued by the broker for more funds.
A representative maintenance margin percentage for long and short positions at many brokerages is 30%.
Well, that is all for today, we will finish off this discussion here.
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