Margin Account Requirements

margin-account-requirementsThis article discusses the rules and regulations that apply to margin accounts at brokerage houses. The basic rules are set by the Federal Reserve Board (FRB), the New York Stock Exchange (NYSE), and the National Association of Securities Dealers (NASD). Every broker must apply the minimum rules to customers, but a broker is free to apply more stringent requirements. Also see the article elsewhere in the FAQ for an explanation of a margin account versus a cash account.

Buying on margin means that your broker loans you money to make a purchase. But how much can you borrow? As it turns out, the amount of debt that you can establish and maintain with your broker is closely regulated. Here is a summary of those regulations.

The Federal Reserve Board’s Regulation T states how much money you may borrow to establish a new position. Briefly, you may borrow 50% of the cost of the new position. For example, $100,000 of cash can be used to buy $200,000 worth of stock.

The NYSE’s Rule 431 and the NASD’s Rule 2520 both state how much money you can continue to borrow to hold an open position. In brief, you must maintain 25% equity for long positions and 30% equity for short positions. Continuing the example in which $100,000 was used to buy $200,000 of stock, the account holder would have to keep holdings of $50,000 in the account to maintain the open long position. The best holding in this case is of course cash; a $200,000 margined position can be kept open with $50,000 of cash. If the account holder wants to use fully paid securities to meet the maintenance requirement, then securities (i.e., stock) with a loan value of $50,000 are required. See the rule above – you can only borrow up to 50% – so to achieve a loan value of $50,000, the account holder must have at least $100,000 of fully paid securities in the account.

If the value of the customer’s holdings drops to less than 25% of the value of open positions (maybe some stocks fell in price dramatically), than the brokerage house is required to impose a margin call on the account holder. This means that the person must either sell open positions, or deposit cash and/or securities, until the account equity returns to 25%. If the account holder doesn’t meet the margin call, then four times the amount of the call will be liquidated within the account.

Here are a few examples, showing Long Market, Short Market, Debit Balance, Credit Balance, and Equity numbers for various situations. Remember, Equity is the Long Market Value plus the Credit Balance, less any Short Market Value and Debit Balance. (The Current Market Value of securities is the Long Market value less the Short Market value.) The Credit Balance is cash – money that is left over after everything is paid and all margin requirements are satisfied. This is supposed to give a feel for how a brokerage statement is marked to market each day.

So in the first example, a customer buys 100,000 worth of some stock on margin. The 50% margin requirement (Regulation T) can be met with either stock or cash.

To satisfy the margin requirement with cash, the customer must deposit 50,000 in cash. The account will then appears as follows; the “Equity” reflects the cash deposit:

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

100,000 0 0 50,000 50,000

To satisfy the margin requirement with stock, the customer must deposit marginable stock with a loan value of 50,000 (two times the amount of the call). The account will then appears as follows; the 200,000 of long market consists of 100,000 stock deposited to meet reg. T and 100,000 of the stock purchased on margin:

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

200,000 0 0 100,000 100,000

Here’s a new example. What if the account looks like this:

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

20,000 0 0 17,000 3,000

The maintenance requirement calls for an equity position that is 25% of 20,000 which is 5,000, but equity is only 3,000. Because the equity is less than 25% of the market value, a maintenance (aka margin) call is triggered. The call is for the difference between the requirement and actual equity, which is 5,000 – 3,000 or 2000. To meet the call, either 2,000 of cash or 4,000 of stock must be deposited. Here is what would happen if the account holder deposits 2,000 in cash; note that the cash deposit pays down the loan.

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

20,000 0 0 15,000 5,000

Here is what would happen if the account holder deposits 4,000 of stock:

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

24,000 0 0 17,000 7,000

Ok, now what happens if the account holder does not meet the call? As mentioned above, four times the amount of the call will be sold. So stock in the amount of 8,000 will be sold and the account will look like this:

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

12,000 0 0 9,000 3,000

In the case of short sales, Regulation T imposes an initial margin requirement of 150%. This sounds extreme, but the first 100% of the requirement can be satisified by the proceeds of the short sale, leaving just 50% for the customer to maintain in margin (so it looks much like the situation for going long). To maintain a short position, rule 2520 requires margin of $5 per share or 30 percent of the current market value (whichever is greater).

Let’s say a person shorts $10,000 worth of stock. They must have securities with a loan value of at least $5,000 to comply with regulation T. In this example, to keep things simple, the customer deposits cash. So the Credit Balance consists of the 10,000 in proceeds from the short sale plus the 5,000 Regulation T deposit. Remember that market value is long market value minus short market value, and because we gave our customer no securities in this example, the “long market” value is zero, making the market value negative.

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

0 10,000 15,000 0 5,000

While we’re discussing shorting, what about being short against the box? (Also see the FAQ article about short-against-the-box positions.) When an individual is long a stock position and then shorts the same stock, a separate margin requirement is applicable. When shorting a position that is long in an account the requirement is 5% of the market value of the underlying stock. Let’s say the original stock holding of $100,000 was purchased on margin (with a corresponding 50% requirement). And the same holding is sold short against the box, yielding $100,000 of proceeds that is shown in the Credit Balance column, plus a cash deposit of $5,000. The account would look like this:

 

Long
Market
Short
Market
Credit
Balance
Debit
Balance
Equity

Initial position 100,000 50,000 50,000
Sell short 0 100,000 105,000 100,000 5,000
Net 100,000 100,000 105,000 150,000 55,000

Customer accounts are suppsed to be checked for compliance with Regulation T and Rule 2520 at the end of each trading day. A brokerage house may impose a margin call on an account holder at any time during the day, though.

Finally, special conditions apply to day-traders. Check with your broker.

Here are some additional resources:


Article Credits:
Contributed-By: Chris Lott, John Marucco