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.

Contact Us:

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of elder abuse, exploitation and securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.

At the Boca Raton Law Office of Russell L. Forkey, we represent clients throughout South and Central Florida, including Fort Lauderdale, West Palm Beach, Boca Raton, Sunrise, Plantation, Coral Springs, Deerfield Beach, Pompano Beach, Delray, Boynton Beach, Hollywood, Lake Worth, Royal Palm Beach, Manalapan, Jupiter, Gulf Stream, Wellington, Fort Pierce, Stuart, Palm City, Jupiter, Miami, Orlando, Maitland, Winter Park, Altamonte Springs, Lake Mary, Heathrow, Melbourne, Palm Bay, Cocoa Beach, Vero Beach, Daytona Beach, Deland, New Smyrna Beach, Ormand Beach, Broward County, Palm Beach County, Dade County, Orange County, Seminole County, Martin County, Brevard County, Indian River County, Volusia County and Monroe County, Florida. The law office of Russell L. Forkey also represents South American, Canadian and other foreign residents that do business with U.S. financial institutions, investment advisors, brokerage and precious metal firms.

What are some of the risks associated with trading options?

Options like other securities carry no guarantees, and investors should be aware that it is possible to lose all of your initial investment, and sometimes more. For example:

Option holders risk the entire amount of the premium paid to purchase the option. If a holder’s option expires “out-of-the-money” the entire premium will be lost.

Option writers may carry an even higher level of risk since certain types of options contracts can expose writers to unlimited potential losses.

Other risks associated with trading options include:

Market Risk – Extreme market volatility near an expiration date could cause price changes that result in the option expiring worthless.

Underlying Asset Risk – Since options derive their value from an underlying asset, which may be a stock or securities index, any risk factors that impact the price of the underlying asset will also indirectly impact the price and value of the option.

Contact Us:

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of elder abuse, exploitation and securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.

At the Boca Raton Law Office of Russell L. Forkey, we represent clients throughout South and Central Florida, including Fort Lauderdale, West Palm Beach, Boca Raton, Sunrise, Plantation, Coral Springs, Deerfield Beach, Pompano Beach, Delray, Boynton Beach, Hollywood, Lake Worth, Royal Palm Beach, Manalapan, Jupiter, Gulf Stream, Wellington, Fort Pierce, Stuart, Palm City, Jupiter, Miami, Orlando, Maitland, Winter Park, Altamonte Springs, Lake Mary, Heathrow, Melbourne, Palm Bay, Cocoa Beach, Vero Beach, Daytona Beach, Deland, New Smyrna Beach, Ormand Beach, Broward County, Palm Beach County, Dade County, Orange County, Seminole County, Martin County, Brevard County, Indian River County, Volusia County and Monroe County, Florida. The law office of Russell L. Forkey also represents South American, Canadian and other foreign residents that do business with U.S. financial institutions, investment advisors, brokerage and precious metal firms.

Options Trading:

Market Participants – There are generally four types of market participants in options trading: (1) buyer of calls; (2) sellers of calls; (3) buyers of puts; and (4) sellers of puts.

Opening a Position – When you buy or write a new options contract, you are establishing an open position. That means that you have established one side of an options contract and will be matched with a buyer or seller on the other side of the contract.

Closing a Position – If you already hold an options contract or have written one, but want to get out of the contract, you can close your position, which means either selling the same option you bought (if you are a holder), or buying the same option contract you sold (if you are a writer).

The following are examples of basic call and put option transactions:

Call Option: On December 1, 2014, ABC Stock is trading at $68 per share. You believe the price of ABC stock will rise soon and decide to purchase an ABC December 70 Call. The premium is $2.20 for the ABC December 70 Call. The expiration date of the option is the third Friday of December and the strike price is $70. The total price of the contract is $2.20 x 100 = $220 (plus commissions which we will not account for in this example).

Since the strike price of the call option is $70, the stock must rise above $70 before the call option is “in-the-money.” Additionally, since the contract premium is $2.20 per share, the price of ABC would need to rise to $72.20 in order for you to break even on the transaction.

Two weeks later the stock price has risen to $80. As the value of the underlying stock has increased, the premium on the ABC December 70 Call has also increased to $10.20, making the option contract now worth $10.20 x 100 = $1020. If you sell the option now (closing your position) you would collect the difference between the premium you paid and the current premium $1020-$220 = $800 (minus any commission costs). Alternatively, you could exercise the option and buy the underlying shares from the writer of the call for $70 (the strike price); the writer is obligated to sell the buyer those shares at $70 even though their market value is $80.

Now, suppose you believe the price of the stock will continue rising until the expiration date and you decide to wait to sell or exercise the option. Unfortunately, the stock price drops to $65 on the expiration date. Since this is less than the $70 strike price, the option is out-of-the-money and expires worthless. This means you will have lost the initial $220 premium you paid for the options contract.

Put Option: On December 1, 2014, ABC Stock is trading at $72 per share. You believe the price of ABC stock will fall soon and decide to purchase an ABC December 70 Put. The premium is $2.20 for the ABC December 70 Put. The expiration date of the option is the third Friday of December and the strike price is $70. The total price of the contract is $2.20 x 100 = $220 (plus commissions which we will not account for in this example).

Since the strike price of the put option is $70, the stock must drop below $70 before the put option is “in-the-money.” Additionally, since the contract premium is $2.20 per share, the price of ABC would need to drop to $67.80 in order for you to break even on the transaction.

Two weeks later the stock price has dropped to $60. As the value of the underlying stock has decreased, the premium on the ABC December 70 Put has increased to $10.20, making the option contract now worth $10.20 x 100 = $1020. If you sell the option now (closing your position) you would collect the difference between the premium you paid and the current premium $1020-$220 = $800 (minus any commission costs). Alternatively, you could exercise the option and sell the underlying shares to the writer of the put for $70 (the strike price); the writer is obligated to buy those shares at $70 even though their market value is $60.

Now, suppose you believe the price of the stock will continue dropping up until the expiration date and you decide to wait to sell or exercise the option. Unfortunately, the stock price rises to $75 on the expiration date. Since this is more than the $70 strike price, the option is out-of-the-money and expires worthless. This means you will have lost the initial $220 premium you paid for the options contract.

These two examples provide you with a basic idea of how options transactions may operate. Investors should note that these examples are some of the most basic forms of options. Many options contracts and the trading strategies that utilize them are much more complex. Consequently, option trading may not be suitable for a risk adverse investor.

Please keep in mind that the above information is being provided for educational purposes only. It is not designed to be complete in all material respects. Thus, it should not be relied upon a legal or investment advise. If you have any questions concerning the above, you should contact a qualified professional.