Volatility—market swings—can sometimes bring an uncomfortable surprise to investors: a margin call.
When you buy stock on margin, your brokerage firm lends you cash, using assets in your account as collateral, to purchase securities. To trade on margin, you must have a margin account with your brokerage firm. Margin accounts are also needed when selling stocks you don’t own, known as “shorting.” In this case, your brokerage lends you the stock you want to sell. You also need a margin account for many options trading strategies.
How You Could Get "The Call"
There are three ways to receive a margin call:
- You trade for more than the buying power in your account.
- The value of your margin account decreases.
- Your broker raises the house maintenance margin requirements.
Let’s explore each case.
First case: You trade for more than the buying power in your account.
In general, under Federal Reserve Board Regulation T (commonly referred to as Reg T), firms can initially lend a customer up to 50 percent of the total purchase price of an eligible stock. But in some cases, a firm might restrict you from buying or owning certain securities on margin. This can include stocks that don’t trade on a national exchange, such as the NYSE or Nasdaq, and might also include stocks the firm believes to be particularly susceptible to large daily price swings.
For example, let's say you have buying power of $2,000 and buy $10,000 worth of a stock on margin, and your firm will lend you half the amount. Under Reg T, you have "one payment period," which is currently four business days from the trade date, to meet the initial margin requirement of $4,000—50 percent of $8,000 (i.e., the total purchase price less the buying power). However, the firm may shorten the payment period and might require you to deposit a higher initial margin amount. (Note: For trades on or after May 28, 2024, the payment period will be three days.)
If you don't meet this deadline, regardless of whether the stock you purchased on margin moves up or down, you’ll get a margin call requiring you to deposit $4,000. In exceptional circ*mstances, the firm may allow you additional time (this is known as an extension), but they aren’t required to do so. If you don’t make your deposit and the firm doesn’t grant you an extension, the firm must liquidate assets in your account. The firm can sell the shares you bought on margin or can sell other assets in your account.
An important side note: Though there is no requirement to deposit cash to open a margin account, FINRA rules require your account have a value of at least $2,000 before engaging in margin trading.
(If you engage in day trading, learn more about pattern day trading requirements.)
Second case: The value of your margin account decreases.
Another way to get a margin call is if your account equity drops below either the firm or FINRA maintenance margin requirements. When you trade on margin, your account must maintain a minimum value. The term used to describe the value of a margin account may vary from firm to firm, but some common terms are “account equity” and “liquidation value.”
FINRA rules supplement the requirements of Reg T by placing "maintenance" margin requirements on customer margin accounts. As a general matter, a customer's equity in a margin account must not fall below 25 percent of the current market value of the long securities (those that are fully paid for) in the account.
Firms may also set margin requirements of their own—often called "house" requirements—that can be higher than the margin requirements under Reg T or the rules of FINRA and the exchanges. For instance, a firm might set the maintenance margin at 30 or even 40 percent of the current market value of the securities in your account. Furthermore, firms can increase the house requirements at any time and aren’t required to provide you with advanced written notice.
Third case: Your broker raises the house maintenance margin requirements.
There can be a case where you can get a margin call even if you didn’t trade or your account didn’t lose value. This can happen when the firm raises the house margin requirements on either a security or group of securities in your account. For example, a firm may increase its house margin requirements when a company is bankrupt, delisted (no longer trades on an exchange) or experiencing large daily price swings (volatility). Firms might also apply higher house requirements to certain groups of stocks in specific industries or sectors.
An important reality check: A firm isn’t required to notify you if your account equity drops below the minimum maintenance equity. Firms don’t have to issue a margin call before selling securities in your margin account to meet a margin call and may sell enough securities to completely pay off your margin loan, not just meet the margin call. Also, firms don’t have to let you choose which securities or assets are sold to meet a margin call.
How Do I Meet My Margin Call?
You can address a margin call in the following ways:
- Deposit cash for the amount of the margin call.
- Deposit margin-eligible securities. When meeting a margin call with securities, the value of securities you deposit must be higher than the amount of the margin call. For example, if you have a house margin call of $6,000, and have a stock in another account with a house requirement of 40 percent, you must deposit $10,000 of that stock to meet the house margin call. The formula for doing is as follows:
Margin call amount ÷ (100% less the margin requirement %):
$6,000 ÷ .6 = $10,000
- Sell securities in your account. The value of securities of that you must sell may be significantly more than the value of the call. For example, if you have a house margin call of $6,000, and you sell a security in your account that has a house requirement of 40 percent, you must sell $15,000 to meet the house margin call. Here's the formula to arrive at this amount:
Margin call amount ÷ the margin requirement %:
6,000 ÷ .4 = $15,000
Please note that these examples only apply in situations where there is a margin loan and might not apply in accounts with short positions or options.
Read and Monitor
These actions can help you understand what triggers a margin call and, by extension, avoid or prepare for one:
- Read your margin agreement. This may be a part of a general brokerage agreement, or it may be a stand-alone agreement. Either way, read the margin disclosure carefully. It's here that the terms and conditions of margin loans are explained and also how the securities you purchase serve as collateral.
- See if your firm issues intraday margin calls. Sometimes referred to as "real-time margin,” a call might be issued after a big intraday dip in the market, instead of at market close. Firms may even automatically sell securities in your account and not issue an intraday margin call. Prepare yourself by understanding your firm’s maintenance requirement—and monitoring your specific maintenance requirement.
- Know your cushion—the maintenance margin excess in your account. This will help you understand how much your portfolio can decline in value before triggering a margin call. If you aren't sure how a maintenance call might be triggered, ask a registered professional to paint a scenario or two.
In short, know the rules—and stay abreast of market conditions to monitor when you might be getting close to a margin call. You might not be able to avoid “the call,” but at least it won't come as a big surprise.
