Margin Money - Meaning, Examples, Uses & Advantages & Disadvantages
In derivative trading, “margin” refers to the amount of money or equity an investor must maintain in their brokerage account to facilitate trading with borrowed funds. Margin money functions as security, protecting against potential losses that might occur during the trading process. Engaging in margin trading for derivatives enables investors to increase their exposure to the underlying assets.
Key Highlights
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Margin borrowing provides flexibility, allowing investors to benefit from returns without investing the entire value of the security, known as leverage.
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To meet the margin call, the investor must either deposit more funds or sell securities to restore the required equity level.
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Actively monitoring positions is important in margin trading to respond quickly to market fluctuations.
Understanding Margin and Margin Trading
Margin and margin trading play significant roles in the stock market, providing investors with opportunities to increase their investment positions. Margin is the amount of money or securities that an investor must deposit with a broker to open or maintain a trading position. It acts as collateral and ensures that the investor has the financial capacity to cover potential losses.
Margin trading involves using borrowed funds, usually provided by the broker, to increase the size of a trading position beyond the investor’s cash balance. This leverage enables traders to potentially increase their returns.
Initial Margin
The initial margin is the cash deposit necessary when initiating a new futures position, calculated as a percentage of the entire contract value. Whether one opts for a long or short position in futures contracts, the requirement for the initial margin remains applicable in futures trading. The calculation of the initial margin depends on a percentage of the total value associated with the futures contracts, and this percentage varies based on the specific futures market being traded. If your account has an initial margin requirement of 50%, and you intend to buy a security valued at ₹10,000, your margin amount will be ₹5,000.
How is Margin Money Calculated?
Margin money is calculated based on regulations by the Securities and Exchange Board of India (SEBI) and depends on the type of trade: intraday, delivery, futures, or options.
For equity delivery trades, you need to pay the full trade value upfront. Margin financing is not allowed. For intraday trades, brokers can offer leverage, but the maximum margin must comply with SEBI’s peak margin norms, which require investors to maintain at least 100% of the margin upfront. In the case of futures and options, margins include two components:
SPAN Margin: It covers the risk of potential losses from daily price movements.
Exposure Margin: An additional buffer collected by exchanges.
The total margin required is the sum of these components and is blocked in your trading account.
Suppose you wish to buy 100 shares of Reliance Industries at ₹2,500 each. The total value is ₹2,50,000. If you are trading intraday and your broker requires a 20% margin, you must keep ₹50,000 in your account. For delivery, however, you would need the full ₹2,50,000.
Note: SEBI has introduced enhanced Extreme Loss Margin (ELM), especially for short options positions, and removed expiry-day calendar spread margin benefits, increasing capital requirements on expiry days.
Advantages and Disadvantages of Margin Borrowing
While margin borrowing offers the potential for enhanced gains, it requires a careful assessment of market conditions and a thorough understanding of the associated risks. Some key advantages and disadvantages of margin borrowing are explained as follows.
| Advantages | Disadvantages |
|---|---|
Using leverage has the potential to generate higher profits. | Leverage can also lead to increased losses. |
It enhances the borrower’s flexibility, allowing them to buy a greater number of securities than their initial capital would permit. | It may result in account fees and elevated interest charges. |
It offers greater flexibility compared to other loans, and regular EMI payments may not be required. | In case of margin calls, the borrower might need to contribute additional funds to cover the losses. |
A self-reinforcing cycle may boost the value of collateral, allowing the borrower to experience increased leverage. | If forced liquidation occurs, the selling of securities can lead to an overall loss. |
Example of Margin
Suppose you deposit ₹10,000 into your margin account, which allows you to borrow ₹20,000 as you’ve already covered 50% of the buying price. If you acquire stock valued at ₹5,000, you still have ₹15,000 of remaining buying power in your account, with enough cash to fulfil the transaction without utilising your margin. The buying power of the margin depends on the security’s value. Given that the values of securities fluctuate daily, the buying power will also vary accordingly.
Other Uses of Margin
The income statement of a business serves as a valuable tool for calculating different accounting margins. These margins, derived from the disparities between expenses and revenue, offer insights into the business’s health across immediate, medium-term, and long-term periods.
- Gross Margin
The gross margin is calculated as the difference between sales and the cost of goods. This margin provides an initial snapshot of the profitability of the core business operations.
- Operating Margin
The operating margin is determined by deducting both the cost of goods and operating expenses from sales. It digs deeper into the operational efficiency and profitability of the business.
- Profit Margin
The profit margin represents the difference between sales and all incurred expenses. This comprehensive margin offers a holistic view of the net profit earned by the business, making it a crucial metric for investors and stakeholders.
What Are the Risks of Margin Trading?
Engaging in margin trading is a complex process that involves notable risks. The risks associated with margin trading are explained as follows.
- Increased Losses
Engaging in margin trading has the potential to amplify an investor’s profits significantly. However, it can equally escalate losses, sometimes exceeding the initial investment amount. Some traders may perceive owing money to brokers as a simpler alternative to dealing with traditional banks or financial institutions, but the obligations incurred in this form of debt are just as binding.
- Margin Calls
A margin call occurs when a broker requests the trader to inject additional funds into a margin account until it reaches the mandated margin maintenance level. If the positions held by the borrower incur substantial losses due to underperforming securities, the margin account may fall below a specified threshold. In such instances, the investor must either sell a portion or the entirety of the assets in the account or contribute additional funds to meet the margin requirement.
- Liquidation
Subject to the conditions outlined in the margin loan agreement, a broker retains the authority to take corrective action if the investor fails to fulfil their commitment. For instance, if the investor cannot meet a margin call, the brokerage firm possesses the right to liquidate any remaining assets in the margin account.
Margin Call: What It Means and How to Avoid It
A margin call happens when the value of your investments bought with borrowed money (margin) falls below the broker’s minimum maintenance requirement. In simple terms, it is a demand from your broker to add more funds or securities to your trading account to cover potential losses. If you fail to do so, the broker can sell your securities without your permission to recover the loaned amount.
Most brokers require traders to maintain a maintenance margin (a minimum percentage of equity in the account). If your equity drops below this level because of market fluctuations, you will receive a margin call.
Suppose you buy shares worth ₹2,00,000 using ₹1,00,000 of your own money and ₹1,00,000 borrowed from the broker. If the broker’s maintenance margin is 30%, your account equity should not fall below ₹60,000 (30% of ₹2,00,000). Now, if the stock value drops to ₹1,50,000, your equity becomes only ₹50,000. Since it’s below ₹60,000, the broker issues a margin call.
To avoid the margin call, keep the following pointers in mind:
- Avoid over-leveraging; borrow within limits.
- Keep extra funds in your trading account.
- Monitor positions daily and set stop-loss orders.
- Diversify investments to reduce sudden losses.
Difference Between Margin Money and Down Payment
Here are the key distinctions between margin money and down payment:
| Parameters | Margin Money | Down Payment |
|---|---|---|
Meaning | Margin money is the minimum amount an investor deposits with a broker to trade using leverage. | A down payment is the upfront amount paid by a buyer when purchasing an asset like a house, car, or gadget. |
Purpose | It secures trades and covers potential losses in case of market fluctuations. | It reduces the loan amount borrowed from a bank or lender. |
Usage | Common in stock, derivatives, and commodity trading. | Common in loans like home, car, or consumer durable loans. |
Risk | Exposes the investor to higher risk due to leverage. Losses can exceed the margin. | Lower financial risk, as it’s a one-time payment; it reduces the EMI burden. |
Conclusion
Margin trading provides investors with leverage, enabling them to buy a greater number of securities than they could with their own capital. This increases both potential gains and losses in margin trading. Investing a margin of the total security value allows for the possibility of increased profits. Conversely, if the security’s value decreases, the potential losses are proportionately significant. To optimise the advantages of this tool, investors should implement a carefully planned strategy. It’s advisable to use margin trading for short-term investments and carefully select securities to minimise risks.
FAQs on Margin Money
What is the Margin in Stocks?
Margin in stocks is borrowed money from a broker that allows you to buy more shares than your own capital permits. You pay a portion (margin) and the broker lends the rest. While it increases buying power and potential returns, it also magnifies risks, as losses may exceed your initial investment.
How Much Margin Money is Required?
SEBI mandates upfront margin collection for equity trades based on Standard Portfolio Analysis of Risk (SPAN) and exposure margins. The requirement typically ranges from 20% to 100% of trade value, depending on stock volatility. For margin trading, brokers may finance the balance, but investors must deposit the prescribed margin upfront.
Is the Margin Money Refundable?
Yes, margin money is refundable if unused or if the position is squared off without loss. In India, SEBI mandates brokers to return excess margin promptly. However, the used margin for losses or leveraged trades isn’t refunded. Refund timelines vary by broker, but must comply with SEBI’s investor protection norms.
What Happens if I Lose Margin Money?
If you lose margin money in trading, it means your position incurred losses beyond your initial margin. Brokers may liquidate your holdings to recover dues. SEBI rules allow this to prevent systemic risk. You are liable for any shortfall, and additional funds may be demanded. Losses are real and not refunded.
Can I withdraw the margin money?
Yes, you can draw unused margin money from your trading account. SEBI regulations require brokers to return excess or unutilised margin promptly. If your pledged securities are released or your cash margin is not used for trades, you may withdraw them.
Is margin money different from collateral?
Yes, margin money is different from collateral. Collateral is an asset offered as security for a loan, while margin money is a cash contribution.
Can I use margin money to buy more stocks?
Yes, the purpose of margin money is to allow investors to amplify their buying power and acquire more stocks than their own funds would permit
What happens if I don’t pay margin money in stock trading?
Failure to maintain the required margin may result in a margin call, where the investor must either deposit additional funds or sell some securities to meet the margin requirement.
Can I use margin money for long-term investments in the stock market?
While margin trading is possible for short-term investments, using margin money for long-term investments is generally not recommended due to increased risks.
Can margin money be utilised for trading options in the stock market?
Yes, margin money can be used in options trading, allowing investors to leverage their positions in the options market.
This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
Investments in securities market are subject to market risks, read all the related documents carefully before investing. Brokerage will not exceed SEBI prescribed limit. The securities are quoted as an example and not as a recommendation. SEBI Registration No-INZ000200137 Member Id NSE-08081; BSE-673; MSE-1024, MCX-56285, NCDEX-1262.
