Margin Calls

• By Blogger
• 21 August, 2013
• 2 Comments

Meeting margin calls

In order to protect investors from over extending their margin purchases, the Investment Dealers Association and the exchanges have established what is called a “minimum margin requirement.” This is the minimum amount of equity expressed as a percentage of the current market value of your stock position which must be in your account. These are the minimum requirements but individual broker/dealer firms can and do set more stringent requirements.

To make the point especially clear, let’s say that Disney’s stock drops not by $20 per share but by $30 per share. When you originally bought your 100 shares of Disney at $80 per share, your account looked like this:

Current Market Value  $8,000   Debit Balance  $5600

———   Equity  $2400

But after the $30 price drop, your margin account looks like this:

Current Market Value  $5,000   Debit Balance (from original transaction)  $5,600   Loan Value of Equity (at new market price) $3,500   Margin Call (original debit balance less new loan value based on current market value)  $2100

As you can see, after the price drop, the loan value in your account has fallen below the initial loan value or debit balance. Whenever that happens, we try to send you a courtesy message via email telling you that you have a “margin call”. However, it is important that you monitor your own account closely because there can be times when we will have to liquidate securities in your account to cover margin calls without notifying you beforehand. We can liquidate at any time, especially if the value of the stock is declining rapidly. In addition, a stock will no longer be eligible for margin if it declines below $2.50 per share. That event could also trigger a margin call.

There are two ways to meet a margin call:

Sending in Funds: We prefer that you send in funds for the amount you owe. This is the best way for you to assure yourself that your account will not be sold out on the due date. Please note that if your equity continues to drop, in most cases, you will receive an additional margin call. If the drop is severe, we may be forced to sell out your account anyway.

Please note: Our Margin Department will look at how much equity is in your account on the day the call is due to determine if you have put equity into the account to adequately cover the call.

The way we actually bring your account back into balance is by adjusting your debit balance. And cash deposit in a margin account is always applied against the debit balance. In this case, your debit balance would be reduced by the $2100 and the minimum margin requirement would be re-established.

Current Market Value  $5,000   Debit Balance (after deposit of $2,100)  $3,500

———   Equity  $1,500

Liquidating Securities: If you cannot bring in the required funds, or do not want to, you may liquidate enough shares in your account to bring your equity up to minimum requirements. Please note that the amount of stock you must sell is greater than if you were to send in funds. If you do this, however, you are not guaranteed to avoid a sell out. If you liquidate out of the margin call, your equity continues to decrease, or you do not sell enough to meet the call, you may be issued another call, or you may be subject to a sell out by our Margin Department.

If you choose to liquidate out of a margin call by liquidating marginable securities, you must be aware that you only receive in cash a percentage of the proceeds equal to your current equity percent.

If the account equity is below 50%, you will usually need to sell at least 2 times the amount due to cover the call. If the account equity is less than 30%, you may need to sell around 3 times the amount due.

Remember that these are approximate numbers and that you should make sure that any transactions you make have fully covered the margin call by checking your account balances the next day.

If on the other hand, you choose to liquidate out of a call with fully paid for cash securities, you must sell enough securities to generate the cash required to meet the call. The full dollar amount of the proceeds will be credited to the call.

What Happens if You Fail to Meet a Margin Call?

A margin call requires you to restore your account to the minimum maintenance requirement level by a specific date, usually within three business days of receiving the call. If you do not meet the due date yourself, we may  sell a portion of your long stock position to bring the equity percentage back. You are responsible for any losses taken in the stock during this process.