Margin (finance)

In finance, margin is collateral that the holder of a financial instrument has to deposit
with a counterparty (most often their broker or an exchange) to cover some or all of the
credit risk the holder poses for the counterparty. This risk can arise if the holder has
done any of the following:

Borrowed cash from the counterparty to buy financial instruments,

Sold financial instruments short, or

Entered into a derivative contract.

The collateral for a margin account can be the cash deposited in the account or
securities provided, and represents the funds available to the account holder for further
share trading. On United States futures exchanges, margins were formerly called
performance bonds. Most of the exchanges today use SPAN ("Standard Portfolio
Analysis of Risk") methodology, which was developed by the Chicago Mercantile
Exchange in 1988, for calculating margins for options and futures.

Margin account
A margin account is a loan account by a share trader with a broker which can be used
for share trading. The funds available under the margin loan are determined by the
broker based on the securities owned and provided by the trader, which act as collateral
over the loan. The broker usually has the right to change the percentage of the value of
each security it will allow towards further advances to the trader, and may consequently
make a margin call if the balance available falls below the amount actually utilised. In
any event, the broker will usually charge interest, and other fees, on the amount drawn
on the margin account.
If the balance of a margin account is negative, the amount is owed to the broker, and
usually attracts interest. If the balance is positive, the money is available to the account
holder to reinvest, or may be withdrawn by the holder or left in the account and may
earn interest. In terms of futures and cleared derivatives, the margin balance would refer
to the total value of collateral pledged to the CCP (Central Counterparty Clearing) and
or futures commission merchants.

Margin buying
Examples
Jane buys a share in a company for
$100 using $20 of her own money
and $80 borrowed from her broker.
The net value (the share price minus

the amount borrowed) is $20. The

broker wants a minimum margin
requirement of $10.
Suppose the share price drops to $85.
The net value is now only $5 (the
previous net value of $20 minus the
share's $15 drop in price), so, to
maintain the broker's minimum
margin, Jane needs to increase this net
value to $10 or more, either by selling
the share or repaying part of the loan.
Margin buying refers to the buying of securities with cash borrowed from a broker,
using other securities as collateral. This has the effect of magnifying any profit or loss
made on the securities. The securities serve as collateral for the loan. The net valuethe
difference between the value of the securities and the loanis initially equal to the
amount of one's own cash used. This difference has to stay above a minimum margin
requirement, the purpose of which is to protect the broker against a fall in the value of
the securities to the point that the investor can no longer cover the loan.
In the 1920s, margin requirements were loose. In other words, brokers required
investors to put in very little of their own money. Whereas today, the Federal Reserve's
margin requirement (under Regulation T) limits debt to 50 percent. During the 1920s
leverage rates of up to 90 percent debt were not uncommon.[1] When the stock market
started to contract, many individuals received margin calls. They had to deliver more
money to their brokers or their shares would be sold. Since many individuals did not
have the equity to cover their margin positions, their shares were sold, causing further
market declines and further margin calls. This was one of the major contributing factors
which led to the Stock Market Crash of 1929, which in turn contributed to the Great
Depression.[1] However, as reported in Peter Rappoport and Eugene N. White's 1994
paper published in The American Economic Review, "Was the Crash of 1929 Expected",
[2]
all sources indicate that beginning in either late 1928 or early 1929, "margin
requirements began to rise to historic new levels. The typical peak rates on brokers'
loans were 4050 percent. Brokerage houses followed suit and demanded higher margin
from investors".

Types of margin requirements

The current liquidating margin is the value of a security's position if the

position were liquidated now. In other words, if the holder has a short position,
this is the money needed to buy back; if they are long, it is the money they can
raise by selling it.

The variation margin or mark to market is not collateral, but a daily payment
of profits and losses. Futures are marked-to-market every day, so the current
price is compared to the previous day's price. The profit or loss on the day of a

position is then paid to or debited from the holder by the futures exchange. This
is possible, because the exchange is the central counterparty to all contracts, and
the number of long contracts equals the number of short contracts. Certain other
exchange traded derivatives, such as options on futures contracts, are marked-tomarket in the same way.

The seller of an option has the obligation to deliver the underlying of the option
if it is exercised. To ensure they can fulfill this obligation, they have to deposit
collateral. This premium margin is equal to the premium that they would need
to pay to buy back the option and close out their position.

Additional margin is intended to cover a potential fall in the value of the

position on the following trading day. This is calculated as the potential loss in a
worst-case scenario.

SMA and portfolio margins offer alternative rules for U.S. and NYSE regulatory
margin requirements.[clarification needed]

Margin strategies
Enhanced leverage is a strategy offered by some brokers that provides 4:1 or 6:1+
leverage. This requires maintaining two sets of accounts, long and short.
Example 1
An investor sells a call option, where the buyer has the right to buy 100 shares in
Universal Widgets S.A. at 90. He receives an option premium of 14. The
value of the option is 14, so this is the premium margin. The exchange has
calculated, using historical prices, that the option value will not exceed 17 the
next day, with 99% certainty. Therefore, the additional margin requirement is set
at 3, and the investor has to post at least 14 + 3 = 17 in his margin account
as collateral.
Example 2
Futures contracts on sweet crude oil closed the day at $65. The exchange sets the
additional margin requirement at $2, which the holder of a long position pays as
collateral in her margin account. A day later, the futures close at $66. The
exchange now pays the profit of $1 in the mark-to-market to the holder. The
margin account still holds only the $2.
Example 3
An investor is long 50 shares in Universal Widgets Ltd, trading at 120 pence
(1.20) each. The broker sets an additional margin requirement of 20 pence per
share, so 10 for the total position. The current liquidating margin is currently
60 "in favour of the investor". The minimum margin requirement is now -60 +
10 = -50. In other words, the investor can run a deficit of 50 in his margin
account and still fulfil his margin obligations. This is the same as saying he can
borrow up to 50 from the broker.

Initial and maintenance margin requirements

The initial margin requirement is the amount of collateral required to open a margin
account. Thereafter, the collateral required until the account is closed is the
maintenance requirement. The maintenance requirement is the minimum amount of
collateral required to keep the account open and is generally lower than the initial
requirement. This allows the price to move against the margin without forcing a margin
call immediately after the initial transaction. When the total value of collateral after
haircuts dips below the maintenance margin requirement, the position holder must
pledge additional collateral to bring their total balance after haircuts back up to or above
the initial margin requirement. On instruments determined to be especially risky,
however, the regulators, the exchange, or the broker may set the maintenance
requirement higher than normal or equal to the initial requirement to reduce their
exposure to the risk accepted by the trader. For speculative futures and derivatives
clearing accounts, futures commission merchants may charge a premium or margin
multiplier to exchange requirements. This is typically an additional 10%-25%.

Margin call
The broker may at any time revise the value of the collateral securities (margin), based,
for example, on market factors. If this results in the market value of the collateral
securities for a margin account falling below the revised margin, the broker or exchange
immediately issues a "margin call", requiring the investor to bring the margin account
back into line. To do so, the investor must either pay funds (the call) into the margin
account, provide additional collateral or dispose some of the securities. If the investor
fails to bring the account back into line, the broker can sell the investor's collateral
securities to bring the account back into line.
If a margin call occurs unexpectedly, it can cause a domino effect of selling which will
lead to other margin calls and so forth, effectively crashing an asset class or group of
asset classes. The "Bunker Hunt Day" crash of the silver market on Silver Thursday,
March 27, 1980 is one such example. This situation most frequently happens as a result
of an adverse change in the market value of the leveraged asset or contract. It could also
happen when the margin requirement is raised, either due to increased volatility or due
to legislation. In extreme cases, certain securities may cease to qualify for margin
trading; in such a case, the brokerage will require the trader to either fully fund their
position, or to liquidate it.

Price of stock for margin calls

The minimum margin requirement, sometimes called the maintenance margin
requirement, is the ratio set for:

(Stock Equity Leveraged Dollars) to Stock Equity

Stock Equity being the stock price multiplied by the number of stocks bought,
and leveraged dollars being the amount borrowed in the margin account.

E.g., An investor bought 1,000 shares of ABC company each priced at $50. If
the initial margin requirement were 60%:

Stock Equity: $50 1,000 = $50,000

Leveraged Dollars or amount borrowed: ($50 1,000) (100% 60%) =

$20,000

So the maintenance margin requirement uses the variables above to form a ratio that
investors have to abide by in order to keep the account active.
Assume the maintenance margin requirement is 25%. That means the customer has to
maintain Net Value equal to 25% of the total stock equity. That means they have to
maintain net equity of $50,000 0.25 = $12,500. So at what price would the investor be
getting a margin call? For stock price P the stock equity will be (in this example)
1,000P.

(Current Market Value Amount Borrowed) / Current Market Value = 25%

(1,000P - 20,000) / 1000P = 0.25

(1,000P - 20,000) = 250P

750P = $20,000

P = $20,000/750 = $26.66 / share

So if the stock price drops from $50 to $26.66, investors will be called to add additional
funds to the account to make up for the loss in stock equity.
Alternatively, one can calculate P using
where P0 is the initial price of the stock. Let's use the same example to demonstrate this:

Reduced margins
Margin requirements are reduced for positions that offset each other. For instance spread
traders who have offsetting futures contracts do not have to deposit collateral both for
their short position and their long position. The exchange calculates the loss in a worstcase scenario of the total position. Similarly an investor who creates a collar has
reduced risk since any loss on the call is offset by a gain in the stock, and a large loss in
the stock is offset by a gain on the put; in general, covered calls have less strict
requirements than naked call writing.

Margin-equity ratio
The margin-equity ratio is a term used by speculators, representing the amount of their
trading capital that is being held as margin at any particular time. Traders would rarely

(and unadvisedly) hold 100% of their capital as margin. The probability of losing their
entire capital at some point would be high. By contrast, if the margin-equity ratio is so
low as to make the trader's capital equal to the value of the futures contract itself, then
they would not profit from the inherent leverage implicit in futures trading. A
conservative trader might hold a margin-equity ratio of 15%, while a more aggressive
trader might hold 4%.

Return on margin
Return on margin (ROM) is often used to judge performance because it represents the
net gain or net loss compared to the exchange's perceived risk as reflected in required
margin. ROM may be calculated (realized return) / (initial margin). The annualized
ROM is equal to
(ROM + 1)(1/trade duration in years) - 1
For example, if a trader earns 10% on margin in two months, that would be about 77%
annualized
Annualized ROM = (ROM +1)1/(2/12) - 1
that is, Annualized ROM = 1.16 - 1 = 77%
Sometimes, return on margin will also take into account peripheral charges such as
brokerage fees and interest paid on the sum borrowed. The margin interest rate is
usually based on the broker's call.