Monday, September 23, 2013

How to Buy Stocks Putting Up Only 1% (No it's not the futures market, it's stocks)

Generally when you invest in stocks on margin, you normally have to put up 50% of the value of the stock, and you have a maintenance requirement of 30%. However, how would you like to have a margin requirement of only 1%, yes one percent! Think of the leverage you would have. Risks? I'll talk about risks in a minute.

This has nothing to do with the futures market, it is entirely legal, and it is offered by a major US investment brokerage firm.  Here are the details.

TDAmeritrade has now come up with something called Portfolio Margin for certain clients, which looks at the whole portfolio instead of individual stocks and options. Let's look at how this would work. This example is similar to what was shown in a write-up in an email flyer from TDAmeritrade.

Let's say you own 100 shares of a $100 stock for a total of $10,000 and a put on that stock with a strike price of 100 and a cost of 1 (or $100). Initially, you would put up $5,100. To maintain the position, you would need to have $3,000 or 30%. However, under this new Portfolio Margin Requirement, the maintenance amount would only be $100.

But wait a minute, you might say; what about the risk to both you and the brokerage firm? In actuality, your total risk is only $100. Let's examine what would happen in three scenarios.

  • The stock drops to $80 a share. You lose $2000 on the stock but make $2000 on the put (actually a profit of $1900 on the put for a net loss of only $100)
  • The stock does nothing. You make nothing on the stock and lose $100 on the put, for a net loss of only $100.
  • The stock goes to $120. You make $2000 on the stock, and lose $100 on the put, for a net profit of $1900.

    So there you have it. Maximum total loss of only $100 and unlimited upside potential. This frees up a lot of cash in your portfolio and provides you with a huge amount of leverage.

    I see only one major risk with the Portfolio Margin program from TDAmeritrade. If the put is very close to expiration, and you haven't made provisions to roll it over, and something happens to you where you are incapacitated and unable to access your account prior to the put expiring, you could have some major problems. Also, keep in mind that the higher the leverage, the more margin interest you would have to pay.

  • 1 comment:

    shahadat hussain said...

    By the end of the 1960s, pension funds,
    insurance companies and individuals owned 67% of all the shares on the Share Market.
    But today they are just minnows next to the global hedge funds that really control Britain's companies.