Understanding Excess Margin Deposit
Margin trading requires an additional deposit based on the current account value minus the maintenance minimum. A negative deposit leads to the risk of a margin call. Regulations set equity levels, but brokerage firms can adopt stricter rules. The Financial Industry Regulatory Authority (FINRA) oversees these regulations. The initial margin must be at least 50% of the trade.
An excess margin deposit pertains to the surplus collateral held within a margin account, surpassing the necessary minimum to maintain the account's standing. Neglecting to uphold this deposit could potentially lead traders to encounter margin calls.
Key Thoughts on Excess Margin Deposits
Regulation T from the Federal Reserve oversees the minimum deposits required to start a margin trading account in the US. FINRA controls the minimum collateral levels in these accounts. The extra collateral beyond these rules is called the excess margin deposit.
Under Regulation T, traders can borrow up to 50% of a stock's price if it's eligible for margin trading. However, some stocks, such as those with small market capitalizations, might be ineligible. This 50% represents the initial margin. Brokerages are allowed to set stricter standards than Regulation T, such as enforcing a 70% initial margin instead of a more lenient 30%.
After buying a stock on margin, FINRA requires that the collateral remain above 25% of the securities market value. Brokerages can choose to increase this requirement, for example to 35%, which exceeds FINRA's standard.
Excess Margin Deposits Example
Consider an investor who acquires $20,000 in securities, funding half of it through a $10,000 loan from their brokerage using a margin trading account and supplying the remaining $10,000 as collateral. If the securities drop to $18,000, the account's equity sinks to $8,000 ($18,000 minus $10,000 loan).
Given a 25% maintenance requirement, the account needs a minimum of $4,500 equity ($18,000 multiplied by 0.25) to remain valid. Since the equity of $8,000 surpasses the $4,500 requirement, the account remains unaffected. Consequently, the excess margin deposit totals $3,500 ($8,000 minus $4,500). The choice of utilizing excess margin hinges on using it for another investment or preserving it in case the trade takes an unfavorable turn.
Paying off Margin Loan Without Selling
If you face a margin call, your brokerage can sell all your holdings to cover the margin loan quickly. This is a common approach for them to recover their share. While it might force you to sell at an unfavorable moment, it can benefit you in the long run. It reduces your owed amount, thereby lowering the accrued interest as you pay off the margin loan.
Regulation T by the Federal Reserve Board mandates a 50% minimum coverage of a security's price with cash or collateral in a margin account. Brokerages can impose higher margin requirements (like 70% or 80%), but not lower ones (e.g., 10%). The account holder (investor), not the brokerage, covers the initial margin.
Margin is a trading tool that allows investors to buy more securities than their own funds allow. However, the margin is risky. It can amplify gains but also magnify losses, especially in unfavorable trades. Overleveraging can lead to significant risks, surpassing the consequences of investing only your principal. Thus, exercise caution, assess the risks, and understand how the margin works before using it in your investment strategy.