Margin Call - "Honey, The Phone's For You"

© Copyright D. Alan Carter 
/ All Rights Reserved

This is one phone call you're going to wish you didn't have to take. But take it you must. It means you've lost money on one or more stocks. So much money, that you've tripped the "maintenance margin" percentage (the amount you need to maintain in your margin account after a stock purchase) and your broker is exercising his contractual rights to have you increase your equity in that margin account in order to protect his (the broker's) investment.

Translation: deposit more money into the margin account, or sell enough stock to satisfy the "call." And do it in x business days, or the broker will sell the securities - while reserving the right to do the latter at any time, with or without notice to you.

And you thought telemarketing calls were bad.

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Margin Call - DreadedMargin Call - The Triggers

A margin call is typically triggered by drop in the share price of a stock owned in your margin account. Let's go back to our hypothetical example of SkyHigh Sausage, of which you bought 500 shares at $10.00 per share, putting up half the money yourself (all the money in your margin account and borrowing the other half on margin. Your net value is $2500 (value of shares - your loan, or $5000 - $2500 = $2500). By law, the broker will have maintenance margin (the amount you need to maintain after the trade) of at least 25% of the market value of the securities in the account at the time of purchase. That means the broker will need to see your equity in the stock at no less than $1250 (25% of $5000).

If the share price of SkyHigh Sausage drops 20% to $8, your net value has shrunk to $1500 (value of shares - loan, or $4000 - $2500 = $1500). You're still within the good graces of the broker, at least with respect to maintenance margin.

But what if the share price drops another $1 to $7? Let's do the math. Value of shares = $3500. Loan = $2500. Your net value is now $1000, a bit below the $1250 (25% of $5000) required for maintenance margin. You will be getting a margin call from your broker for the difference ($250). You will be expected to either wire those funds into your account, or sell sufficient stock to alleviate the deficit.

Keep in mind that a broker may have higher maintenance requirements than required by law, to which you will have to oblige. This is called a "house requirement." In our example above, if your broker had a house requirement of 40%, that would translate into a minimum equity of $2000 on your part. If SkyHigh Sausage dropped to $7, your margin call would be for $1000.

Beyond a drop in the share price of the equities you hold, a margin call can also be triggered simply by a change in your broker's "house requirement." Such a change can come with little or no notice, precipitating a margin call, or "house call."

Margin Call - Courtesy Not Required

Generally speaking, if your margin account falls below your broker's maintenance requirement, your broker will make a margin call to inform you that you need to deposit more cash or securities into your account, or dispose of sufficient securities to alleviate the deficit. In such a case, you will likely be give a number of days to meet the margin call (usually 3-5). If you are unable to meet the margin call within the allowable time frame, your broker will take it upon himself to sell your securities to increase the equity in your account up to or above the firm's maintenance requirement.

But remember - this is a courtesy. Your broker is likely not required to make that margin call, or otherwise tell you that your account has fallen below the firm's maintenance requirement. Indeed, if you'll look over the fine print of the margin agreement you signed, you'll find that your broker may sell the securities in your account at any time without consulting you first. In fact, even if your broker offers you the time to get your finances in order, he can still turn right around and sell your securities - without waiting for you to meet the margin call.

For additional information on margin calls and margin trading: 
U.S. Securities and Exchange Commission - "Margin: Borrowing Money To Pay For Stocks" 
Wikipedia - Margin Trading and Margin Calls

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