Margin Trading refers to the practice by which one can purchase share in the higher amount than the money investor already have and it also helps to sell the security which is not owned by the investor. Margin trading, therefore, is used in both long & short position. Long position refers to buying of security own share in an expectation of drastically or dramatically price increase. But short position refers to selling of own security or short selling of others security, which are not owned by the investor (i.e. short seller). In order to use margin trading, investor opens margin account in the brokerage house and deposits minimum initial down payment as required by that brokerage house and then purchase or sell the security.
Long position and Margin Trading:
Long position refers to buying of securities for oneself with the expectation of price increase. Therefore long position holder will have unlimited profit with limited loss (i.e. not more than 100%). Therefore return for long position holder is summation of capital gain and principal repayment (dividend and interest)
HPR for long position holder = Ep- Bp +DtP1-P0+Dt
Long Position under Margin trading:
Long position is held when one expects that price of the security will dramatically increase. For that, investor opens margin account in brokerage house and deposits minimum initial down payment as per the initial margin. For e.g. if brokerage firm has the provision of 50% for initial margin , an investor who wants to purchase the security of Rs. 1 lakh has to deposit 0.5×100,000=Rs. 50,000 as initial margin . In case of margin trading change in price or fluctuation in price may change the holding of investor in the brokerage house account that is computed by actual margin. When investor clears the entire due amount i.e. provided by brokerage house (loan) with its interest, s/he will have all his/her securities. Under margin trading & for Long position holder, the following components play vital roles.
1. Initial Margin (m)
2. Actual Margin (AM)
3. Maintenance Margin (mm)
4. Maintenance Call
5. Triggering Price /striking price for maintenance call (TP) 6. HPR for long position holder
7. Loan for long position
It refers to the minimum down payment percentage of the total value of share one is willing to purchase. Initial Margin varies from brokerage house to brokerage house as per competition and legal rule.
Market value of assets changes as change in price. This results the change in value of Initial margin. So brokerage house timely check the magnitude of this margin. This new and changed margin is now called Actual margin instead initial margin. In other words, it refers to the degree of holding by the investor as per the price change in the security for the money deposited in the margin account. Therefore actual margin of long position holder increase when the price of the security increased and vice-versa. Actual Margin is computed with the following equation.
Actual Margin = Mkt. value of assets -loan
Mkt. value of assets
= MVA - loan
When the price decreased, long position holder may default to the brokerage house .In order to overcome this risk, if brokerage house sets lower boundary units or limits that is known as Maintenance Margin. Therefore if actual margin is less than or equals to maintenance margin, brokerage house will call for maintenance or in other word investor has to deposit money to maintain maintenance margin all the times.
Maintenance Call is happened to be called when Actual Margin becomes less than equals to Maintenance Margin. For e.g. if maintenance margin is 35% and due to the price depreciation if actual margin becomes 35% or less than 35%, brokerage house will call...