You probably have identified an exciting deal, but it requires you to invest a hefty amount. What will you do? Obviously, you will pay out of pocket. But this solution has two problems. First, if you are low in funds in your DEMAT account, it will take time to arrange additional funds. But, by that time, the deal will be gone. And secondly, it will increase your total risk exposure in the market. However, there is another solution to the problem if your broker offers you margin.
Experienced traders in the market are aware of the facility called margin against shares, and they use it to leverage in the market. So, what is margin against shares? In simple words, it is a lending facility that is offered by your broker as an additional service to help you invest with them. When there is a good deal, you can overdraw your DEMAT account to pay the margin and realise profit without increasing your risk quotient. The broker takes the stocks as collateral and lends you fund to trade on a short-term basis. It happens when the market is bullish, and investors want to optimise their profit.
What is margin against shares?
In the capital market, the definition of margin differs from its general meaning. In the stock market, margin refers to an amount that is only a percentage of total trade volume involved, which the investor must pay upfront to enter the deal. Buying with margin is, therefore, an act of borrowing from the broker to invest in stocks.
Traders use the current stocks available in their accounts as collateral to receive a loan against those. So, it is also called a loan against security.
Margin allows you to buy more stocks than you can buy by extending a line of credit to you, of course, after allowing a haircut. In the capital market, a ‘haircut’ is a term used to describe the difference between the asset’s market value and the amount that can be used for collateral.
How does it work?
You need to find out if your broker offers the margin against shares (MAS) as a value-added service. It works the following way.
- Clients transfer his shares from his personal account to the broker’s beneficiary account
- The broker then shifts those shares to the client’s margin account under the broker’s depository participant
- The margin amount is calculated based on the value of shares, after deducting a haircut
- Clients can use the margin amount on a variety of financial instruments like trading stocks in intraday trading, equity futures trading, indices, currency, and more.
- This margin, however, can’t be used for buying options or for taking delivery of equities
- The client can take back the collateral stocks at any point if he no longer wants to avail the margin
Process and cost of receiving margin
Your MAS account (Margin Against Shares) is different from your DEMAT account. It may come as an additional service when you open DEMAT and trading account with your broker or separately. Some brokers will ask you to make an initial deposit known as the initial margin to activate the account. When the fund in the margin account depletes, the broker will ask you to make more deposits to maintain the initial margin.
Brokers usually don’t charge fees for managing your account, but additional fees may apply for off-market transfers from the client’s account to the margin account.
What happens to the stocks?
The ownership of the shares doesn’t change. The client continues to be the owner of the shares in the margin account. You can use the margin for any period you want if you continue to fulfill the obligations, like paying interest. When you sell shares from your margin account, the proceedings go to the broker to adjust against the margin amount.
Moreover, there are few more things to keep in mind while using margin against shares. Only specific securities can be used as collateral for margin. Ask your broker to give you a list of stocks, bonds, or ETFs that qualify as collateral against margin advances. Once you request for a loan against shares, the broker will extend the amount after deducting exchange approved haircut.
Also, there are exchange imposed restrictions against using 100 percent of the margin for a trade. Exchanges have set cash collateral ratio at 50:50, which means that only 50 percent of the total volume of the deal can be paid using margin, the remaining amount must be fresh cash investment.
Let’s take an instance, suppose you want to purchase NIFTY Futures worth Rs 3,14,120. To place an order for the deal, you will have to pay Rs 1,57,060, which is 50 percent of the deal amount in cash before paying the remaining with margin against shares.
What happens during the profit loss scenario?
If asset price rises as anticipated, your profit is calculated by deducting the margin amount. However, in case of loss, the brokers can sell the stocks pledged as collateral to recover the loan.
Margin against share in a facility that enhances your investment capacity; let you bet for higher stakes with a line of credit from your broker. You can pledge your existing stocks and ETFs as collateral and hedge your net risk meter. But it is a double-sided sword that you must wield with caution.