A margin call happens when the value of a margin account goes below the maintenance margin requirement of the account. It is a demand by a brokerage firm to bring the balance of the account up to the minimum maintenance margin requirement. In order to satisfy the margin call, you will have to either deposit additional funds, sell current positions, or deposit the securities.
The calculation for Margin call price
The formula for a margin call price is as shown below:
Margin call price= Initial purchase price X (1-Initial margin)/ (1-Maintenance margin)
Here, the initial purchase price is the price of a security. The initial margin is the minimum amount required and it is expressed as a percentage. The maintenance margin is the amount of equity that must be maintained in the margin account.
What to do if you are in a margin call
You need to remember that when a margin call is not satisfied, the broker can liquidate the position of the investor. This means, if you do not satisfy the margin call when the price reaches the purchase price, the broker will liquidate your position. A margin call can be covered by depositing the funds to meet the maintenance margin requirement of the account. It can also be met by depositing the securities to meet the maintenance margin requirement or by selling the margined securities to meet the margin requirement of the account.
Getting a margin call
Usually, a margin call is issued by placing a notification on the website when you log in to check the balance in your account. In situations where the broker is not worried about your financial condition, you might be given time to deposit new securities or cash in the account to raise the equity value to a level that is considered acceptable by the internal margin debt guidelines.
If you do not meet the call, the broker may start to sell off your holdings to raise as much cash as they can. The broker will be interested in protecting his financial condition and will not want to go after you to collect the amount. Hence, as per the agreement in your account, there is no obligation to give you time to meet a margin call or to speak to you before the liquidation of assets in your account to cover the margin debt.
Nobody will notify you so you might not get a chance to rectify the situation. At the time of opening your account, you signed an agreement and it stated the margin call circumstances very clearly, and you must live with them.
Not meeting a call
Everyone needs to take margin calls seriously. If not, it can lead to debts which could put you in deep trouble. If you are not able to pay a call, and the assets you own have already been liquidated, you will notice that the remaining amount owed will become an unsecured debt that is default now. It can have an impact on your credit score, insurance rates, and the broker may also launch a lawsuit against you.
Avoiding margin calls
The best way to avoid a margin call is to open cash only account with the firm. It is a lot more convenient and it means that you cannot create margin debt since the securities must be fully paid in cash when you purchase them. However, if you want to leverage in a cash account, you can buy investments like stock options that are fully paid.
This means instead of shorting, you will buy options on the stock. It will have low risks and trade-offs and the maximum amount you can lose is 100% of the value of the stock in addition to the cost of the put. You can also take positions with theoretical and minimize loss. This way, you can keep the money and the amount of interest aside for contingencies in U.S. treasury bills or an insured bank account. It will help cover for the worst-case scenario.
- A margin call is a demand for capital or securities to bring the margin account to the minimum maintenance margin.
- It occurs when the account runs short on funds because of a losing trade.
- If you fail to meet the call, there will be serious consequences.
- Brokers might force traders to sell assets irrespective of the market price, in order to meet the margin call.
Margin calls are a part and parcel of trading. When you open an account, you need to be aware of the terms of the minimum maintenance margin. If you feel that you might not be able to meet the demands, opt for a cash-only account. It will keep your money and assets safe.