Chapter 3 - Margin - Part II

Question 1

Buying power

Answer 1

SMA balance divided by 50% Reg T requirement (i.e. SMA x 2). Means customer can purchase x amount of stock on margin without depositing additional cash.

Question 2

Minimum maintenance requirement (long accounts)

Who is it established by?
What is the % requirement?

Answer 2

Established by FINRA not FRB.

25% minimum for a long account, i.e. equity must be at least 25% of current market value. If equity drops below, BD must call for additional margin (maintenance call/margin call) to bring equity to 25%.

Shortcut to determine trigger point: Debit balance * 4/3 = Market value at which margin call would kick in

Question 3

Guarantees involving customers

Answer 3

Account of a customer may be guaranteed by another customer (must be in writing) , i.e. if a customer’s account becomes undermargined, other customer account equity can be used as collateral

Question 4

Minimum initial equity requirement ($)

Answer 4

$2,000 unless purchase is less than $2,000 (then the requirement is the full purchase price)

Ex. $3,000 initial purchase = $2,000 initial deposit
$1,800 initial purchase = $1,800 initial deposit

Initial deposit requirement only, not maintenance requirement

Question 5

Credit balance

Answer 5

Represents short sale proceeds plus required cash margin deposit

Initial margin requirement is the same 50%

Ex. Customer who sells short $10k worth of stock will be credited $10k proceeds + required to deposit $5k initial margin = $15k credit balance

Question 6

Short market value

Answer 6

Current market price of borrowed stock (amount customer owes back to broker)

Question 7

Calculating equity on short accounts

Answer 7

Credit balance - short market value = equity

Similar to long accounts, formula is always “assets - amount owed = equity”

Question 8

Minimum maintenance requirement (short accounts)

Answer 8

Generally, 30% of market value of short stock

Shortcut to determine trigger point (assuming 30% requirement): credit balance * 10/13 = Market value at which maintenance would kick in

Exceptions:
1. If stock being sold short is valued <$5/share, requirement is $2.50 per share or 100% of the current market value, whichever is greater
2. If stock being sold short is valued between $5 and $16.66/share, requirement is $5.00 per share
3. If stock being sold short is valued >$16.66/share, requirement is 30% of current market value

Question 9

Margin requirements for US Gov’t and Municipal securities

Answer 9

FRB hasn’t established any minimums, leaving it up to SROs

FINRA has set the following:
Governments: Depends on time remaining to maturity, ranging from 1% (<1 year) to 6% (20+ years)
Muni bonds: 7% initial and maintenance requirement

Question 10

Pattern day trader

Answer 10

Customer who day trades 4+ times in a 5-business day period, and number of day trades is >6% of total trades in that period

Gets special rules for margin

If a BD knows or has reason to believe a customer opening an account will engage in pattern day trading, BD can impose special rules immediately

Question 11

Day trading

Answer 11

Purchase and sale (or vice versa) of the same security on the same day in a margin account, except for long/short positions held overnight and sold/purchased the next day prior to any new purchase/sale of the same security

Question 12

Special rules for pattern day traders

Answer 12

1. Minimum equity requirement - $25,000 (rather than normal $2,000) must be deposited before any day-trading begins
2. Margin calls - buying power is limited to 4x the maintenance margin excess, determined as of close the previous day. If day-trader exceeds buying power limit, must meet a day-trading margin call within 5 business days. While this margin call is outstanding, buying power is limited to 2x excess. If call isn’t met by 5th business day, trading is restricted to cash-available for 90 days or until call is met. Funds deposited to meet the call must remain in the account for 2 business days.
3. Cross-guarantees prohibited - can’t meet day-trading margin requirements through use of cross-guarantees (either through account of other customer or another account owned by same customer)

Question 13

Margin on option contracts

Answer 13

Option contracts, while they typically have no loan value, are subject to Reg T margin requirements and exchange maintenance requirements. Since they have no loan value, buyer of an option must deposit the full purchase price, regardless of whether the option is bought in a cash or margin account.

Must be paid for within T+4, then BDs must clear transactions and deposit margin with the OCC the next business day

A BD can require deposit from customers prior to Reg T payment date

Question 14

OCC

Answer 14

Options Clearing Corporation

Question 15

Covered call option

Answer 15

underlying stock/security (or escrow receipt) is on deposit with the firm

Question 16

Escrow receipt

Answer 16

Letter from the bank saying that a stock is on deposit at the bank and will be delivered if the call is exercised

Question 17

Covered put option

Answer 17

Aggregate exercise price (or bank guarantee letter) is on deposit with the firm

Question 18

Bank guarantee letter

Answer 18

Letter from the bank saying that the bank holds cash equal to the aggregate exercise price and will pay against delivery on the underlying stock if the put is exercised

Question 19

Writer

Answer 19

Grantor of an option

Question 20

Margin requirement for covered call writer

Answer 20

None because covered = writer is long the stock or escrow receipt

Question 21

Margin requirement for uncovered call writer

Answer 21

If call is ITM or ATM, 20% market price of the underlying stock + premium (amount ITM is irrelevant)

If call is OOTM, greater of:
1. 20% market price of the underlying stock + premium - amount OOTM
2. 10% market price of the underlying stock + premium

Remember these are to calculate total margin requirement. However, typically the premium is not typically taken into account for the “deposit amount” owed by the writer, since that is paid and deposited by the buyer.

Also pay attention to the NUMBER of calls sold x100 for each

Question 22

In the money (ITM)

Answer 22

Exercise price lower than market price

Question 23

Option premium

Answer 23

“purchase price” of option (remember to assume x100 for 100 share unit)

Question 24

Margin requirement for covered put writer

Answer 24

If writer is short the underlying stock, has cash equal to the exercise price, or has a bank guarantee letter - no margin required

Question 25

Margin requirement for uncovered put writer

Answer 25

ITM/ATM: 20% market price of underlying stock + premium OOTM: greater of: 1. 20% market price of the underlying stock + premium - amount OOTM 2. 10% aggregate strike price of the underlying stock + premium Remember these are to calculate total margin requirement. However, typically the premium is not typically taken into account for the "deposit amount" owed by the writer, since that is paid and deposited by the buyer. Also pay attention to the NUMBER of puts sold x100 for each

Question 26

Margin requirement for leveraged ETF

Answer 26

Multiply standard 25% on long positions/30% on short positions by the ETF's portfolio leverage factor. Ex. if ETF has 2x leverage factor, and client makes $2000 purchase, maintenance requirement is $1000 (25% x 2 x $2000). If client had sold short, it would be $1200 (30% x 2 x $2000)

Question 27

Reg T extension is granted by ____

Answer 27

FINRA

Question 28

Rule 15c2-1

Answer 28

Rule 15c2-1 prohibits certain practices as being fraudulent/deceptive: - Commingling securities carried for the account of a customer with those of another customer without obtaining written consent from both - Commingling securities of a customer with those of any person who is not a customer of the BD, including securities owned by the BD - Hypothecating customer securities for a sum that exceeds the total indebtedness of all customers (i.e. if total margin loans are $500k, bank cannot borrow more than $500k using customer securities as collateral)