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NSDL Newsletter for Investor Education - The Financial Kaleidoscope (June - Sep 2021)

 

NSDL Newsletter for Investor Education
NSDL Newsletter for Investor Education 



Dear Readers,

 

Firstly, we regret the delay in bringing out this edition of the newsletter. We would like to assure readers that we shall attempt to publish the future issues of the newsletter in timely manner.

 

Compounding and leveraging money are two critical aspects of investing and wealth creation and certain instances amid the constant ups and downs of the stock market offer plenty investment opportunities.  However, leveraging these opportunities is not always possible due to limited cash reserves available with most retail investors.


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Margin trading is one such concept that allows investors to trade in equities by paying only a part (or margin) instead of full consideration value of the trade. This is enabled by a broker who funds the balance amount and charges interest to client. The margin can be settled later by squaring off open position.

 

Since there are many factors involved in the process, margin trading facility is practiced more often by seasoned investors than a novice. It takes a fair amount of time to understand the workings of margin trading, so it is always advisable to consult a professional financial or investment planner.

 

To help you get an understanding, in this edition of The Financial Kaleidoscope, we are covering the basics of margin and margin trading. This is not financial advice, but a beginner’s guide in the form of some basic questions you may have before starting.

 

NSDL is now present on LinkedIn. Please visit  https://www.linkedin.com/company/national-securities-and-depository-limited to keep updated about NSDL webinars etc.


Overview of Margin Trading:

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What is margin?

 

 

Let’s take an example. You want to buy 100 shares of ABC Limited which is priced at ₹1,000 per share. The transaction value will be ₹1,00,000. Assuming there is nothing like margin, you will need to pay ₹1,00,000 to broker at the time of placing your buy order.

 

Now, assuming your broker is providing 50% margin facility, you can invest in those shares by paying just ₹50,000. The balance amount is funded by the broker and squared off at settlement.

 

So, in the context of stock markets, margin is the total amount or extent of leverage available to an investor. There are certain rules prescribed by stock exchanges which needs to be followed by your stock broker regarding the extent of margin that can be available to you. This may vary from stock to stock and from time to time.

 

 What is margin trading?

 

Having understood the meaning of Margin, it is easy to understand what is Margin Trading. In simple words, it is a facility provided by stock broker to clients whereby a client can buy or sell securities without paying 100% amount upfront towards purchase consideration or 100% shares that are sold.

 

The part paid by the investor is called ‘Margin’ and the portion that is not paid is the leverage given to client by the broker.

 

Investor can pay the margin in form of cash (not hard cash – by way of bank transfer) or by depositing securities. Securities provided as margin are also known as ‘Collateral’.

 

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What is rational behind Margin Requirements and Margin Trading?

 

  1. Margin trading helps investors to buy securities of their choice without paying the full amount of money beforehand. They can make money when the earning from the trade is more than the margin.
  2. Margin Trading helps in increasing trade volumes.
  3. By enforcing margin requirements, exchange controls the trading activity in the market.
  4. Margin requirements are used by exchanges to manage settlement risks.

What Are the Different Types of Margins?

There are different type of margins applicable to equity trading in India. Each has its own rational. Let’s have a look at the types of margins for cash segment –

 

Value at Risk (VaR) Margin or Initial Margin (IM)

 

It is intended to cover the largest loss that can be encountered on 99% of the days. For liquid stocks, the margin covers one-day losses while for illiquid stocks, it covers three-day losses to allow the exchange to liquidate the position over three days.

 

Extreme Loss Margin (ELM) Margin

 

It is a second line of defense to cover extended losses that go beyond 99% risk which is covered under the VaR margin.

 

Mark to Market (MTM) Margin

 

MTM is calculated on all open positions of an investor on any trading day as difference between transaction price and the closing price of the share. If the closing price is less than the transaction price, then the notional loss needs to be paid to the exchange.


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Peak Margin

 

  1. Peak Margin is the minimum margin that must be collected by brokers from their clients in advance of placing any intraday / delivery order in the Cash and Derivatives segments.
  2. Clearing corporations take at least four random snapshots of all margin status during the trading session.
  3. Brokers gets margin calls from clearing corporation as per their aggregate trading volumes etc. They need to fulfil their margin obligations and report to clearing corporation.
  4. The highest margin requirement that emerges from the different snapshots would become the ‘Peak Margin’ for the day. This peak margin is then compared with the available margin of investors.
  5. Penalty may be imposed by Clearing Corporation on broker if peak margin requirement is more than the available margin. 

 

There have been important changes with respect to peak margin requirements of recently. In order to make markets safer for investors, SEBI directed stock exchanges to increase the peak margin in a phased manner. As can be seen from the graphic below, with effect from September 1, 2021, peak margin requirement is 100%.


How will it impact retail investors?

 

The increasing margin would logically affect regular traders because of their reduced ability to leverage their funds or having to raise additional funds to continue trading.

 

In the earlier system of calculating margin requirement at the end of the day, traders could sell shares of a certain value and buy another lot of shares of the same value due to the net availability of margin.

 

Under the new peak margin system, the margin required for a particular transaction could change throughout the day. This needs investors to maintain additional funds and reduce the risk from intraday transactions.


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Workings of Margin Trading

What is the difference between intraday and delivery trades?

 

 

In simple terms, intraday trade happens when investors buy and sells same quantity of shares on the same day, albeit at different prices. Buy and sell trades are executed with an intention to achieve the situation wherein total quantity sold and bought are same. This results in zero delivery obligation at the end of day for the traders. This is also called as ‘Squaring off’ the positions or trade.

 

If investor do not square off the sell trades at the end of the trading day, then he / she needs to pay for those shares and then shares are delivered or credit to his / her demat account. This kind of trades are known as delivery trade.

What is the rational or purpose behind intraday trades?

 

The main purpose behind undertaking intraday trades is to earn benefit on account of difference in the selling and buying price of the stock.

 

Typically, an intraday trade involves an investor setting target price for specific stocks to trade in. If the share price falls below the target price, investor buys it and sells it as soon as it hits the target price (of course target price will be higher than buy price). Investor also set a stop loss target at which he/she sells shares in case the price falls to limit their intraday losses. 

 

On the other hand, in delivery trading, the shares purchased are credited to investor’s demat account. So, the investor becomes the beneficial owner of the shares and remains so till the shares are sold.

 

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Is intra-day trading possible for all shares?

 

There are some stocks which are traded in ‘Trade for Trade’ segment. Investors need to deliver the gross quantity of shares sold by them which are under this segment. Similarly, they need to pay the full consideration for shares bought by them. In other words, intraday trading is not applicable for such shares.

How to find margin required for any trade?

 

As explained earlier, there are various types of margins applicable on one trade whether buy or sell. Exact margin requirement varies from exchange to exchange. Within the limits prescribed by the exchange, final amount of margin may differ from broker to broker.

 

In general, stock brokers adhere to maximum margin norms prescribed by the exchanges. So, stock exchanges like NSE offer an online calculator to help investors to know the margin requirement before undertaking the trade. 

Click here to check it yourself.

 

What are the implications of not fulfilling margin requirements?

 

In margin trading, it is critical for investors to keep sufficient funds as minimum margin to account for a stock’s volatility through the day. It is particularly important if you intend to hold open positions. If the minimum margin exceeds the available margin during the trading period, it may trigger a margin call. And incase investor fails to meet the gap; it would lead to broker squaring of the position or / and liquidate assets in the margin account of the investor to compensate shortfall. So, once you know your margin obligation, best thing to do is to fulfil it at the earliest.

 

How to fulfill margin requirements?

  1. Margin can be paid by depositing amount in designated bank account of broker.
  2. Margin can also be paid by creating a ‘Margin Pledge’ in favour of the broker.

Modes of providing Margin - Funds

  1. Free and unencumbered Balances (funds and securities) available with the Broker in different segments of the Exchange.
  2. Bank guarantee issued by any approved bank and discharged in favor of the Broker.
  3. Fixed deposit receipts issued by any approved bank and lien marked in favor of the Broker.
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Modes of providing Margin - Securities

  1. Margin Pledge of eligible Securities in dematerialized form with appropriate haircut.
  2. Units of liquid mutual funds in dematerialized form, Government securities and Treasury bills in electronic form with appropriate haircut.
  3. Securities given as margin which are sold in the cash market and the securities are in the pool account of the Trading Broker but are not given as early pay-in, benefit of margin be given to the client till T+1 day from the sale of securities without any haircut.
  4. Free and Unencumbered funds / securities in the demat or bank account of the client for which the client has given Power of Attorney in favor of the broker may be considered as fulfillment of margin requirements by client if broker or its associate company is a DP.
  5. Securities received in pay out shall be considered only after it is actually received from the clearing corporation.
  6. Early pay- in received from clients may be considered while calculating the ledger balance for the purpose of reporting of margins till T+1.

 

What are the margin requirements for Buy Today, Sell Tomorrow transactions?

In case client buys a share on T day with upfront payment of applicable margin and if client sells the same shares on T+1 day, then

 

  1. Client needs to pay separate margin for sale trades also, as Buy and Sell trades are executed in different settlements.
  2. Broker may choose to pay for the buy position of client (buy value – margin paid by the client) and collect the payout of shares on T+2 day in Client Unpaid Securities Account (CUSA).
  3. Broker may deliver the shares from CUSA on T+3 day towards pay-in for sale trade on T+1 day.
  4. Broker may also choose to post the buy and sale value of shares to client’s account upon execution of sale transaction, which could be used towards margin for subsequent trades of the client.
  5. Securities received in pay out and available in CUSA account (reduced by the minimum 20% haircut) after adjusting any debit balances in client ledger shall be considered for collection and reporting of margin.

Margin Pledge

What is margin pledge?

 

A pledge in the context of stock trading is the use of shares as collateral for a loan or monetary advance. A margin pledge is a collateral in the form of securities accepted by intermediaries to receive funds for margin trading. With the use of securities as collaterals, investors can limit their risks. 

 

With all the margin deposits in their possession, brokers and intermediaries who offer margin trading facilities are considered custodians. This led to misuse of client securities and funds by some brokers in recent past

Acting on the concerns arising of this situation, margin pledge requirements were strengthened by SEBI.

 

  1. W.e.f. August 1, 2020, collaterals in form of securities can be accepted by stock brokers only in form of margin pledge created on the securities held in client’s demat account.
  2. Instruction to create margin pledge on securities can be given by client or by the person holding the Power of Attorney, in physical form or electronically through SPEED-e.
  3. Such margin pledge can be created in favour of a specially designated demat account of the stock broker (opened as TM – Client Securities Margin Pledge Account or TM / CM – Client Securities Margin Pledge Account).

How to submit margin pledge instructions?

 

You may fill up, sign and submit ‘Form 43 – Margin Pledge Form’ in paper form to your DP.  NSDL clients can also submit margin pledges electronically through NSDL’s SPEED-e platform if you are a registered user (password user or e-token user). For details, please visit www.eservices.nsdl.com


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Points to keep in mind:

  1. Once created, margin pledge instruction will wait for pledgee’s confirmation to become effective.
  2. If the pledgee has opted for automatic confirmation of pledge instruction, then margin pledge instruction created as above will become effective immediately.
  3. Make sure to create a margin pledge for securities that are approved by your stockbroker for margin purposes.
  4. Create margin pledge for quantity according to the value of the security and haircut applicable.
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