South Florida Arbitration & Litigation Lawyer Blog
Market Volatility – Margin Accounts – Margin Calls, Margin Abuse and Account Deficits Especially Relating to Option Transactions – Boca Raton, Florida Margin Deficit FINRA Arbitration Attorney:
There is a substantial difference between the risks and rewards arising from the use of a margin account as opposed to a cash account. This is especially true when one is exposed to the type of volatility that the markets have recently experienced. It is not uncommon in these types of volatile and fast moving markets, especially when one is on the wrong side of a option position, that all of the account’s equity is lost but that an account deficit might result. In such a situation, it is important to immediately consult with an experienced attorney in such matters. This is especially true if your broker is demanding that the client payoff a deficit in the account.
For the notice investor, the below discussion generally describes the difference between a cash and margin account.
A “cash account” is a type of brokerage account in which the investor must pay the full amount for securities purchased. An investor using a cash account is not allowed to borrow funds from his or her broker-dealer in order to pay for transactions in the account. A “margin account” is a type of brokerage account in which the broker-dealer lends the investor cash, using the account as collateral, to purchase securities. Margin increases investors’ purchasing power, but also exposes investors to the potential for larger losses. Here’s what you need to know about margin.
Understand How Margin Works:
Let’s say you buy a stock for $50 and the price of the stock rises to $75. If you bought the stock in a cash account and paid for it in full, you’ll earn a 50 percent return on your investment. But if you bought the stock on margin-paying $25 in cash and borrowing $25 from your broker-after paying back the broker, you’ll earn a 100 percent return on the $25 you invested (minus any interest you owed the broker). The downside to using margin is that if the stock price decreases, substantial losses can mount quickly. For example, let’s say the stock you bought for $50 falls to $25. If you fully paid for the stock, you’ll lose 50 percent of your money. But if you bought on margin, you’ll lose 100 percent, and you still must come up with the interest you owe on the loan. Investors who put up an initial margin payment for a stock may, from time to time, be required to provide the broker with additional cash or securities if the price of the stock falls. Some investors have been shocked to find out that the brokerage firm has the right to sell their securities that were bought on margin-without any notification and potentially at a substantial loss to the investor. If your broker sells your stock after the price has plummeted, then you’ve lost out on the chance to recoup your losses if themarket bounces back.
Recognize the Risks:
Margin accounts can be very risky and they are not appropriate for everyone. Before opening a margin account, you should fully understand that:
•· You can lose more money than you have invested;
•· You may have to deposit additional cash or securities in your account on short notice to cover market losses;
•· You may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities; and
•· Your brokerage firm may sell some or all of your securities without consulting you to pay off the loan it made to you.
You can protect yourself by:
•· Knowing how a margin account works and what happens if the price of the securities purchased on margin declines.
•· Understanding that your broker charges you interest for borrowing money and how that will affect the total return on your investments.
•· Being aware that not all securities can be purchased on margin.
•· Asking your broker whether trading on margin is appropriate for you in light of your financial resources, investment objectives and risk tolerance.
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