Margin Requirements

Please take note that new day trading margin rules took effect on September 28, 2001.

1) Normal Retail Accounts (designed for the 'buy and hold' client)

One of the least understood investment tools an investor has at his disposal is margin. It is sometimes called a double-edged sword - it is great when the market is going your way but disaster when it does not. It is important to understand that when you use margin to invest YOU CAN LOSE MORE THAN YOUR INVESTMENT.

Here are some frequent concerns that have been brought up by other investors:

A. What is 'margin' and how is it used?

Typically an investor purchases stock and pays the full amount in cash, such as purchasing $10,000 of stock. However, when the investor buys 'on margin,' he pays HALF of the amount and borrows the other half from the brokerage firm; Client buys $ 10,000 of stock, deposits $ 5,000 into his account and borrows $ 5,000 from the firm, paying monthly interest. If the equity increases in value and the client sells at a higher value, the amount borrowed from the firm will be paid back first and the rest belongs to the investor, minus any interest and transaction costs.

If the investment decreases, the brokerage firm will look for ways to protect its money and has established certain levels to protect itself.

Remember, equities bought on margin are held in 'street name' and belong to the firm, not to the customer!

B. What is a 'margin call'?

Using the example from the last question, if the investment decreases too far the firm will require the investor deposit cash or other securities into his account to bring it up to acceptable levels.

As a general rule of thumb the term 'account equity' is the term used to determine what level the investor is for the sake of margin requirements. For an example, if a client purchases $ 10,000 worth of stock on margin, deposits $ 5,000 and borrows $ 5,000 from the brokerage firm, his 'account equity', expressed as a percentage is 50%

The formula: (Current Market Value minus Amount Borrowed) / (Current Market Value)

($ 10,000 - $ 5,000) / ($10,000) or 50%

Now, what happens if the market drops and the value of the investment declines to $8,000, what is the 'account equity' now?

Current Market Value = $ 8,000

Amount borrowed = $ 5,000

($ 8,000 - $ 5,000) / ($8,000) or 37.5%

What happens of it drops further, say to $ 6,000?

($ 6,000 - $ 5,000) / ($6,000) or 20%

Now the account receives what is known as a 'margin call' or the requirement that funds must be deposited to bring the account back up to acceptable levels. Due to the volatility of market nowadays, our clearing firm Penson Financial Services requires that equity not fall below 35%. Should the account equity drop below the requirement level we will require funds to be deposited. If funds are not deposited immediately, the account will could be 'sold out' or liquidated even without the investor's knowledge. It is the client's responsibility to monitor his account equity at all times .

C. How can I meet this 'margin call' ?

There are several ways a margin call can be met. The easiest way is to deposit cash into your account via check or bank wire. Another way is to deposit fully paid for marginable equities. While it is the customer's responsibility to monitor their own account and margin status every morning before trading starts, where possible we will send out a courtesy e-mail to the customer alerting to the problem status; however, a customer should not rely on the firm to alert him/her.

D. What happens if I do not meet this 'margin call'?

Remember that the brokerage firm loaned the investor half of the funds and has an interest in protecting its principle, therefore, an account that does not meet the necessary requirements will could get 'sold out'. Equities in the account will be liquidated in order to meet the necessary balances. Up to three times the call amount may will be liquidated to meet the call.

This can occur with or without customer's knowledge. Once again, it is the client's responsibility to monitor the equity balance.

E. How an account can be 'frozen'?

An account can be frozen when the margin call is not met, i.e., no funds or securities are sent within the required time.

F. What happens when an account is frozen?

Customer funds must be deposited before an order is taken. There will be no grace. (TRADE DATE + 3 days.)

G. What is a Federal call?

A federal call occurs when the investor exceeds their allowable trading limit. For an example, if an investor deposits $ 25,000, allowing him trade $ 50,000, but trades $ 60,000 then the client will have to deposit $ 5,000 in cash or securities. If the client fails to do so for three times, the account could be restricted for 90 days.

DAYTRADING, NEW RULES EFFECTIVE SEPTEMBER 28, 2001

News rules and regulations are now in effect for 'pattern' day traders, i.e., traders who buy and sell four or more times within five business days (i.e., round trips).

In a day trading account:
Minimum account equity (cash value) cannot drop below $ 25,000. Should it drop below $ 25,000 the account will be denied day trading buying power by the clearing firm in accordance with these new rules, until funds are deposited.

For accounts that maintain above $25,000 they currently have access to four times equity (instead of only two). Example, a client deposits $30,000 in cash, they have up to $120,000 buying power during the day.

In a regular retail account:
If a client trades four or more round trips (buy-sell, sell-buy) within five business days, the client will identified a 'pattern day trader' and will fall under the same restrictions as a day trading account, i.e., a $ 25,000 minimum requirement.