Margin refers to collateral that an investor shall deposit with their broker on any borrowing as an assurance to their broker. The margin may be used by the latter to cover risks in the future if incurred. The financial asset that an investor invests in usually becomes the collateral for that transaction.
Margins may be required in the following three conditions – when an investor borrows cash from the broker to buy any financial instruments, when an investor borrows certain financial instruments from the broker to sell them soon, or when they both enter a derivative contract. Buying on margin is the activity that refers to using borrowed money to purchase a security. A margin account is a speculative or leverage account that keeps note of all the transactions taking place between the lender and the borrower.
The law gives the discretion to open a separate margin account to the borrower. A margin account may be opened as part of a standard account opening agreement or you may access it via a new agreement meant specifically for this purpose. A minimum deposit of $2000 is required in a margin account as the first investment. Once the account is open, 50% of the actual price of a security may be borrowed by an investor. This is known as the initial margin. Remember that 50% is the upper cap. You may borrow lesser proportions of money. A minimum account balance has to be maintained by the borrower in the margin account, failing which the broker has the right to ask you for the same. This minimum amount is known as the maintenance margin. The situation where the broker needs to remind you to submit your payments on time is called the margin call. It should also be kept in mind that all stocks cannot be bought on margin. The discretion to allow the same lie with the governing authority, in most cases the central bank of the country.
A margin calculator helps the investor calculate the percentage of margins required and the leverage offered for trades in all the segments. Some important elements of a margin calculator are listed below.
- SPAN Margin
SPAN margin is the collateral that is used to cover any losses against extreme price movements. It is calculated by standardized algorithms and reveals the minimum margin required to carry out a transaction. It is calculated once an investor knows the strike price, risk-free interest rates changes in prices of the underlying securities, changes in volatility, and decreases in time to expiration. SPAN margin acts as a security for the lender because it estimates the margin for the worst possible movement in the system. Daily limit prices that the exchanges set for a commodity are most are the key variables to calculate the SPAN margin.
- Exposure Margin
An exposure margin is a margin charged over and above the SPAN on the wishes of a broker. It is known as an additional margin for the purpose that it is an extra charge. It is charged by a broker to make sure that he does not incur losses of the money or the financial instruments lent to the investor. The biggest fear for a borrower is the erratic swings in the market. The exposure margin is charged so that the broker does not bear the brunt of a loss.
- Total Margin
A total margin is the total or summation of the SPAN margin and the exposure margin. It is an important indicator of the health of security and how much profit it is incurring to the investor.
- Factors that Impact the Risk
Risk is the inherent component of trading. Where there is trading, there is a risk because it is difficult to make accurate predictions about the movements in the economy. Underlying volatility, underlying market price, and expiration date of security are important factors that may or may not disturb the movements. Underlying volatility also called implied volatility, is a metric that predicts movements or deviations in the price of a stock. This in turn is affected by the demand and supply forces of the economy. If one can understand the movements of an asset, they may make huge profits or at least incur the minimum losses possible because then they know how prices will behave. The underlying market price is the spot price of an asset or security. Spot price refers to the value of an asset at a given time and place. It is the key factor determining the ultimate value of a stock. The expiry date refers to the last date on or before which an asset must be put or called.
- Makes Trade Easy
A margin calculator is a beneficial tool for people who are new to the market and need an understanding of every bit of trading. The calculator will give you an estimated amount of money that you must have to purchase or borrow a commodity. Hence, you will not be trapped in debt. The calculator will help one have transparent transactions.
Having a blueprint of how you will proceed with your investment is known as a financial or economic map. It smoothens the process of decision-making. A trader with a financial map will be aware of all sorts of investments he is to make, the margins he needs to pay as well as the risks he may incur. You will also know if you have a good amount of money before you exit from a certain security market.
The margin calculator is a good and safe tool for people who wish to just enter the market or are a part of it. Calculating margins beforehand will help a trader know all the possibilities of movements and volatility of the market. They will also know that the broker is looting them if they have a prior sense of the different margins they will be required to pay. They will know what amount of investment is appropriate for them and what is not and that they do not get cheated on by anybody.