2.1) What is a Margin Account?
A margin account is an account you establish at a brokerage firm that
lets you borrow from your broker. A margin account lets you take a
secured loan against your own portfolio. The advantage is that you
do not have to sell any of your portfolio to obtain the cash.
Furthermore, you generally have no repayment schedule.
You are free to repay the loan at anytime, unless your collateral falls
below the required amount. While most traders use the borrowed
cash to buy additional securities, you can use it for any purpose.
However, the wholly owned securities in your portfolio are collateral
for the loan.
2.2) What is a Portfolio Margin Account?
Generally Portfolio Margining replaces (and eliminates) the
Reg. T requirements, Pattern Day Trader status and
Day Trading Buying Power. It generally results in a
substantial increase in overnight Stock Buying Power, often
increasing by a multiple of times larger than under Reg. T.
Generally Option Buying Power is increased by an even higher
multiple, rising to the same amount as computed for
Stock Buying Power.
Since December 12, 2006 a portfolio margin account is
risk-based using the overall maximum risk of loss in the portfolio
found by stressing the positions in the portfolio across a range of
hypothetical market moves, rather than each individual position in
the portfolio. Initial and maintenance portfolio margin
requirements range from about 6% to 15% equity vrs. 50% initial and
30% maintenance for the normal Reg T Margin Accounts.
Portfolio Margin results in various changes to Stocks Buying Power and
Options Buying Power and Day Trading Buying Power depending on
various minimum account equity values of $25,000, $100,000, $500,000
and $5,000,000. See these links for more information:
2.3) What is a Margin Call?
A margin call is a demand by your broker for you to deposit cash
or fully marginable securities with your broker.
If the value of your collateral falls below the broker’s minimum
requirement (usually about 30% of the loan), you will receive a
margin call by letter, telephone, telegram, or other means, to
request additional collateral in the form of cash or fully
marginable securities to meet the requirement. However, only a
percentage of a security’s market value can be used to meet your
margin call. If you fail to meet the margin call, your broker is
authorized (remember the margin agreement form) to sell the margined
securities and any other collateral needed to repay the loan plus
interest and commissions. You are responsible for any deficit that
may remain after your assets are sold.
2.4) What is an Outstanding Call?
Your account is currently in a Margin Call which generally
needs to be satisfied (or covered) immediately, otherwise
the broker may liquidate your account, generally starting
with selling out the lower priced (riskier) securities.
2.5) What is a “Reg. T” Call?
A “Regulation T Call” is issued when the initial equity for the
purchase of a marginable security in your account is below the
minimum required by the Federal Reserve Board (currently 25%).
Similarly a “Reg. T Call” is issued if the value of your older
securities decline to far, resulting in your account falling below the
minimum level required by the Federal Reserve Board (currently 25%).
Your account will go into an Reg. T call if the initial equity for
the purchase of a security is below the minimum required by the
Federal Reserve Board. If your account goes into a Reg. T call you
can meet it by depositing funds, marginable securities, or
liquidating fully paid-for securities. In a call your broker may
forcibly liquidate your account without prior notice, regardless of
your intent to satisfy the call
These are serious calls and need to be covered “immediately.”
2.6) What is a Fed Call?
A Fed Call is another name for a Regulation T or Reg. T Call.
2.7) What is a Maintenance Call?
A Maintenance Call is issued when the market value
of your margined securities, plus any cash balance in
your account, less the debit balance of your account, drops below
the broker’s maintenance requirements (a percentage ratio computed
from margin debt balance v. marginable account value).
Your account will go into an maintenance call if its value drops
below the broker’s maintenance requirements due to changes in the
market value of a security or when you exceed your buying power. If
your account goes into a maintenance call, you can meet it by
depositing funds, selling stock, or depositing securities. In a call
your broker may forcibly liquidate your account without prior
notice, regardless of your intent to satisfy the call.
2.8) What is a Day Trading Buying Power Call?
If your account meets the minimum equity requirements for day trading
and then exceeds the day trading buying power on executed trades
this creates a special maintenance margin deficiency. As a result
a day trading buying power call will be issued. Once a day trading
buying power call is issued, the day trading buying power is restricted
to two times margin maintenance excess for 5 business days unless
the call is met earlier. If the Day Trading Buying Power Call is not met
within 5 business days, the account will be permitted to execute
transactions on a cash available basis for 90 days or until the call is
met. Multiple day trading buying power violations may result in a
restriction limiting transactions to a cash available basis.
Potentially day trading calls can only be met by depositing cash or
fully paid securities, or by selling non-marginable securities.
2.9) What is a “Friendly Loan” used to cover a Day Trading Buying Power Call?
Until the Day Trading Buying Power Call is met by depositing cash,
the account remains restricted, pursuant to NASD Rule 2520(iv)(c).
Pursuant to NASD Rule 2520(iv)(e) the cash must be deposited and
cannot be withdrawn for a minimum of two business days following the
close of business on the day of deposit.
Here’s where the “friendly loan” comes into play: Some boutique
brokerages have been known to look the other way when an
“arrangement” is made between two of their customers to transfer
funds from an unrestricted account, into the account with the Day
Trading Buying Power Call. Similarly there are “angels” who,
for a reasonable fee, will lend the cash for a few days to accounts
to meet their Day Trading Buying Power Call. If discovered,
such “friendly loans” may be subject to NASD disciplinary action under
NASD Rule 2370.
You can legitimately accomplish nearly the same thing by taking out an advance on
a home equity line of credit, or a cash advance on a Mastercard/VISA.
The NASD now accepts the fact that friendly loans are a part of life
and should be none of their business.
click here for original source of this statement:
In some cases, firms may arrange loans for
customers from other sources, and there have been instances of
customers making loans to other customers to finance securities
trades. A customer that lends money to another customer should be
careful to understand the significant additional risks that he or
she faces as a result of the loan, and needs to carefully read any
loan authorization forms. A lending customer should be aware that
such a loan may be unsecured and may not be eligible for protection
by the Securities Investor Protection Corporation (SIPC). The firm
may not, without direction from the borrowing customer, transfer
money from the borrowing customer’s account to the lending
customer’s account to repay the loan.
2.10) What is a Day Trading Minimum Equity Call?
If your account has less than $25,000 day trading equity
and is identified as a pattern day trading account, a
day trading minimum equity call will be issued.
Officially it is said that pattern day trader accounts that fall below
the $25,000 minimum equity requirement should consider limiting day trading
activities to cash only transactions until the minimum equity amount
is reached in order to avoid a Day Trading Buying Power Call.
A Day Trading Buying Power Call (see FAQ 2.8) is issued when you do
two or more day trade round trips within one single day and
you then in effect have used the unreplenished day trading buying
power (by buying the later positions using your regular buying power
rather than the unavailable day trading buying power).
2.11) How is Buying Power computed?
Generally computed by taking “Available Funds” and
dividing it by some factor. Normally this is 0.3501
(or 0.30 or even as low as 0.25 which is the mandated federal
minimum)) as the factor as applied to “House
Surplus Available Funds.” i.e. if you had $100,000 of House
Surplus available funds at the beginning of the day, then
100,000/.3501 equals $285,632.67 of Buying Power for the day.
Otherwise 0.50 is the factor as applied to “SMA Available Funds”
if this computes a lower number. i.e. if you had $100,000 of SMA
available funds at the beginning of the day, then 100,000/.50
equals $200,000 of Buying Power for the day. Since $200,000
is less than $285,632.67, your Buying Power would be throttled
back or limited to the lower $200,000 number.
Non-marginable securities, such as stock options, have buying power
of “Available Funds” less any “Pending Cash Deposits.”
2.12) How are “Available Funds” computed?
“Available Funds” is the lower of Special Memorandum Account (SMA)
Value or House Surplus. The House Surplus is the Marginable Equity
Values less the Maintenance Requirement. The SMA is some “mystical”
account valuation that generally bears little resemblance to reality.
Usually your SMA exceeds your House Surplus so it doesn’t matter much.
SMA increases 100% for all cash deposited to your account and by 50%
of net daily changes in securities purchases and sales. SMA
decreases 100% for all cash withdrawals. Depreciated security
values (trading losses) do not lower the SMA account balance, hence
over time the SMA tends to climb higher than your House Surplus
2.13) How is Day Trading Buying Power computed?
Margin Maintenance Excess or SRO Value is used to compute Day
Trading Buying Power. To get to Margin Maintenance Excess or
SRO Value one brokerage that I interviewed takes your Marginable
Net Equity and subtracts 25% of the value of marginable long
positions priced over $1.00 and subtracts 100% of the value of
marginable long positions priced under $1.01.
The resulting amount, the Margin Maintenance Excess or SRO Value,
is then multiplied by 2 for PDT account values under $25,000 or is
multiplied by 4 for PDT account values over $25,000.
Example: $100,000 market value of IBM stock and $30,000 cash for a
total account value of $130,000.
Day Trading Buying Power = ($100,000 * 75% + $30,000) * 4 = ($75,000
+ $30,000) * 4 = $105,000 * 4 = $420,000.
Trick: Since available cash that is swept into an outside, overnight,
money market fund is no longer “cash” nor marginable by these
definitions, this sweep action can drastically lower your Day
Trading Buying Power. To maintain higher Day Trading Buying Power
turn off automatic sweeping of available cash balances.
2.14) What is Free-Riding? (cash accounts and the pattern daytrader overnight positions trap)
Purchasing a security and then selling it prior to actually
“paying for” the security (or never separately paying
for the security, but rather using the sales proceeds to cover the
A practice in which a brokerage client buys a security in a cash
account and sells the same security without putting up money for the
purchase, an activity that encourages speculation and violates the
credit extension provisions of the Federal Reserve Board. The
penalty for free-riding requires that the customer’s account be
frozen for 90 days
Buying and immediately selling securities without making payment.
This practice violates Regulation T.
The brokerage account can be flagged as having had a “liquidation violation”
and repetitive violations can lead to trading restrictions being placed
on the account and even on the tax ID# of the account (meaning it
can be a restriction across multiple brokerage accounts).
This trading violation is the result of buying a security in your
cash account and then selling the same security without making
separate payment on the full purchase price by Settlement Date. This
situation is called free-riding because basically it is unauthorized
borrowing to pay for a trade.
Trading in a cash account using unsettled sales proceeds (rather
than trading in a margin account) or trading in a Pattern Day
Trading Account, when overnight open positions are closed out, makes
a securities trader particularly susceptible to inadvertently
violating the free-riding rule. A violation often requires a
truly immediate cash deposit into the account (i.e. more
immediate than even a Reg. T Margin Call), otherwise the
account may be restricted when making future securities purchases.
There are tricks to help traders trapped by a free-riding violation
and there are rules to prevent the tricks from circumventing the
potential restriction: such as transferring available excess cash
from the account of another trader (a friend, or even an unknown
party who is introduced via the brokerage) to be repaid back
immediately once the free-riding issue is settled. (see
“friendly loan,” above)
Exception: Trading “when issued” securities.
Exception: Sometimes in a pattern daytrader account an
automatic exercise of an in-the-money call option after the close on
Friday, can be sold on the following Monday without a free-riding
violation. There may be technical differences between a normal
expiration trade date of the 3rd Friday of the month (which expires
on the following Saturday) and the weekly Friday expiration dates.
Regulation T of the Federal Reserve Board does not allow
investors to buy a security low and sell it high, during the
same trading day, and use the proceeds of its sale to pay for the
original purchase of the security. The penalty requires that the
customer’s account remain frozen for 90 days.
Exception: Traders using a Pattern Day Trader account.
2.15) What is Free-Riding? (IPO rule)
NASD Rule 2790 or the old “Hot Issues” Rule and the old “Free-Riding
and Withholding Interpretation.”
Free-Riding is a practice prohibited by the Securities Exchange
Commission and the NASD, in which an underwriter holds back a
quantity of Initial Public Offering (IPO) shares in order to subsequently sell them at a
2.16) What is a “cabinet trade”?
An accommodation liquidations of an out-of-the-money option
position. In lieu of closing the position with a “market order”
a trader can close the position in a cabinet trade which the
brokerage will do as a courtesy, often for zero commission
and at a price of a penny for the entire lot (for the entire
cabinet) of option contracts held.
In a closing transaction, the Order Book Official will accept limit
orders from holders and writers of “out the money” contracts to
close the positions at a total premium of $1 per contract ($.01 per
share) or even less (as little as $0.000001 per cabinet has been
observed). The OBO will match the orders as an accommodation, and
report the executed trades to the firm that placed the order. Filing a CEA
(Contrary Exercise Advice) is not appropriate, since the customer
does not want to exercise the contract.
2.17) What is “loss prevention”?
A brokerage must monitor its customer margin accounts for potential
“at risk” positions that could result in a full liquidation of the account
with a resulting loss to the brokerage for any negative account value.
2.18) What is the Margin Requirement for a Concentrated Account?
Example: When one position comprises greater than 70% of the value
of an account the margin requirement for that concentrated position
rises from say 30% to 35% due to the risk of having “all your eggs
in one basket.” If the one position comprises greater than 90% of
the value of an account the margin requirement for that
concentrated position rises further to say 40%.
2.19) What are “seg funds”?
Segregated Funds are customer funds which are held by futures
brokers that back up all the positions its customers hold in the markets.
2.20) What is Cash-up-front?
A requirement for funds on deposit or on receipt in a brokerage
office at the time you enter your order. Cash-up-front is
required to trade certain types of securities and is also
required for all orders placed in accounts that have a
cash-up-front restriction imposed on them.
2.21) What is a Side Letter?
A side letter is a special arrangement between a fund
and an investor, granting preferential terms, often in a quid pro
quo arrangement, often to the detriment of the other investors in
the hedge fund. Side Pockets have been used to pocket
agreement to hide poor investment decisions, resulting in
misleading investors regarding the actual performance. Investors
need to be alert to hedge funds giving preferential treatment to
2.22) What is a Side Pocket?
A side pocket is a portion of a hedge fund with a liquidity provision
that differs from the rest of the fund’s capital. It may have its own
separate contribution and redemption rules.
This is a method for the fund to invest into longer-term
illiquid investments including real estate and angel financing
of development stage, privately held enterprises.
2.23) What is two and twenty?
Typical compensation structure for a hedge
fund manager. That is an annual fee of 2% of the total net asset
value of the fund, plus 20% of the net profits realized.
Optionally, a Hurdle is a benchmark that must be exceeded before the
20% kicks-in. And generally, any losses from prior quarters
must be recovered before the 20% kicks-in.
2.24) What is Cost of Carry?
Expenses incurred while a position is being held;
for example, interest on securities bought on margin,
dividends paid on short positions, and other expenses.
2.25) What is the Carry Trade?
A trade where you borrow and pay interest in order to buy something
else that has higher interest. For example, with a positively sloped
term structure (short rates lower than long rates), one might borrow
at low short term rates and finance the purchase of long-term bonds.
The carry return is the coupon on the bonds minus the interest costs
of the short-term borrowing. Of course, if long-term interest rates
unexpectedly rose (and long-term bond prices fell as a result),
the carry trade could become unprofitable. Indeed, if this occurred,
there could be a number of investors trying to unwind the carry trade,
which would involve selling the long-term bonds. It is possible that
this could exacerbate the increase in long-term interest rates,
i.e. push the rates even higher.
Carrying over the opportunity to make money by borrowing money at
say 1% and then, for example, reinvesting those borrowed proceeds at 2%.
2.26) What is the Currency Carry Trade?
A strategy where an investor borrows in a foreign country with
lower interest rates than their home country and invests the
funds in their domestic market, usually in fixed-income securities.
There is a risk with the uncertainty of exchange rates. You’ve
still got to pay back the money in a foreign currency. If your
domestic currency falls in value relative to the currency you
borrowed, then you run the risk of losing money. Also, these
transactions are generally done with a lot of leverage, so a
small movement in exchange rates can result in huge losses unless
An example of a “yen carry trade” is borrowing 1,000 yen from
a Japanese bank, exchanging the funds into U.S. dollars and
buying a bond for the equivalent amount. Assuming that the
bond pays more than the amount you must pay the bank for
borrowing the funds, and the exchange rate does not move
adversely, you will earn a profit.
2.27) Treasury Bonds?
Treasury notes and bonds are securities that have a stated
interest rate that is paid semi-annually until maturity
Treasury bonds are long-term investments with a term
greater than 10 years. For example: The 30-Year Bond.
2.28) Treasury Notes?
Treasury notes and bonds are securities that have a stated interest
rate that is paid semi-annually until maturity. Treasury notes
are long-term investments with a terms of 10 years or less
Notes are issued in two-, three-, five- and 10-year terms.
T-bills are short-term obligations issued with a term of one year
or less. They are sold at a discount from face value rather than
making interest payments. The interest therefore is the
difference between the purchase price and the price paid either
at maturity (face value) or the price of the bill if sold prior to maturity.
Treasury Inflation-Protected Securities are U.S. Treasury instruments
that pay a fixed rate of interest two times a year and they provide
protection against inflation. The principal of a TIPS increases with
inflation and decreases with deflation, as measured by the Consumer
Price Index. When a TIPS matures, you are paid the adjusted
principal or original principal, whichever is greater.
2.31) Treasury FRNs – Treasury Floaters?
Floating Rate Notes are U.S. Treasury instruments that will pay a floating rate
of interest two times a year and they provide protection against inflation.
Unlike TIPS, the principal does not change with deflation. When a TIPS
matures, you will be paid the original principal amount.
2.32) Other Margin Information