University of Miami Margin Trading Discussion
Prior to completing your journal, read in your textbook Jones, C. P., & Jensen, G. R. (2020). Investments: Analysis and management (14th ed.). Chapter 5, “ How Securities Are Traded”
In your assignment be sure to address the following:
Summarize margin trading.
Using another classmate’s margin transaction from the discussion board, compare the amount of your margin call given a 10 or 20% decline to the classmate’s margin call under the same scenario.
Explain the differences.
Identify the benefits and disadvantages of using margin transactions.
TO COMPLETE THE ASSIGNMENT PLEASE SEE MY ORIGINAL POST BELOW
For this week’s discussion I decided to utilize a stock I have been following for some time. The name of the stock is Crowdstrike (CRWD) and it has been extremely volatile during the past month, with constant ups and downs and with the price ranging from $235 to $296. The stock priced doubled during last year, and even though the trend has been positive, it still showed significant ups and downs. This is the reason why I made a stop short order at a target price of $260. This represents a decrease of 5.6% decrease from the opening price of $275.54 today. The short order wasn’t executed because the price fell to as low as $263 before It bounced back and closed at $269.
Assuming that the price had actually fallen to $260, and the short order would have been executed, it would have resulted in a loss (thankfully it didn’t happen) because the stock bounced back in the same day. Something similar occurred yesterday, with the stock price starting at $266.58 and then falling to $264. Later, it bounced to $268. The stock volatility is very high especially since analysts have been starting to downgrade the stock from buy to hold. The company hasn’t been able to make a profit although it has potential in the cloud services industry.
If the short sale order had been executed (assuming a theoretic price of $260):
Stock: CRWD
Market price: $260
Total price: $26,000
Initial margin (as a % of total portfolio) 16.7%, or $26,000
The minimum maintenance margin varies between 25% to 40%, depending on the investor’s client history and past performance. Since we are starting to trade, a 40% margin call would probably be more realistic. In this case, the actual margin is much lower since a total of 10 stocks were acquired for $115,620, and the stock price of Crowdstrike is high but not that high. It would have been different with other stocks like Amazon with a closing price of $3,384 per share. Trading on a margin allows investors to leverage their trading and it also increases potential profits and losses. Sometimes, margin trading can actually result in heavy losses and the investor ends up losing all the money and even owing money to the broker. Not considering meme stocks like GameStop, traders lost more than $38 billion by short selling Tesla last year (Winck, 2021).
The potential impact if this transaction had been carried out would be a loss of $9.17 per stock or $917 in total not including broker fees. Again, luckily the order was not executed.
CLASSMATES ORIGINAL POST
For this assignment, I have chosen one stock and structured a margin transaction to purchase one round lot of stock based on the requirements in Stock-Trak.
Stock
Market Price
One Round Lot Stock Count
Total Price of One Round Lot
JPMorgan Chase & Co. (JPM)
$168.29
100
$16,829
After determining the chosen stock, market price, and the price of one round lot of stock, the initial margin and maintenance margin can be calculated. Margin is the equity that an investor has in a transaction. According to the reading this week, “The initial margin requirement must be met when the transaction is initiated, but the maintenance margin must be met on an ongoing basis.” (Jones & Jenson, 2020). The current initial margin requirement set by the Fed is 50%. The next step is to multiply the purchase price by the initial margin requirement of 50%. The calculation would be as follows: $16,829 x 50% = $8,414.50. Now the maintenance margin can be calculated. The maintenance margin is the percentage of the value of a transaction that must be on hand at all times as equity (Jones & Jenson, 2020). Brokers generally require 30%. FINRA states that 25% of the total value of the securities margin account is required. For this example, 30% will be utilized as the percentage of the transaction that must be on hand at all times.. The formula for maintenance margin multiples the total investment by the percentage required to be on hand. The calculation for maintenance margin would be as follows: $16,829 x 30% = $5,048.70. This means that the equity in the margin account must be at least $5,048.70.
Some investors may rely strictly on the cash they have on hand when making investment decisions. Leverage gives an investor a way to borrow money or increase the number of shares involved in a trade beyond the number of shares which could be afforded with only cash (Porter, 2021). An example is trading on margin. Trading on margin means that an investor borrows money from a broker to make an investment by using other assets in a brokerage account as collateral (Porter, 2021). Generally, when one references a company or investor as “highly leveraged”, this means that the company or investor has more debt than equity. For this transaction, the use of margin can be used as leverage which would allow the investor to increase their buying power in the financial market by using existing cash or securities as collateral.