Transcript: Understand margin trading and make it work for you

[Music plays.]

[CIBC logo

CIBC Investor’s Edge

Understand margin trading and make it work for you]

[A mobile phone is shown displaying a line graph.]

[Rob, a CIBC Investor’s Edge employee, stands and speaks.]

>> Rob: Understand margin trading and make it work for you. You’ve probably heard the term “buying on margin,” and you’d like to know more about it. Why do investors use it? What does it accomplish? Here’s what you need to know. 

[A graphic is titled: “Buying stock with Margin”. To the left an icon of a dollar with an arrow curving upwards is shown. To the right of this is: “Borrow money to finance part of purchase”. Below a new icon of a coin with a percentage sign is added, and beside this is: “Interest is paid on amount borrowed”. Below a new icon of a bar graph is added and beside this is: “Equity in account must be maintained at a certain level”.]

When you buy stock using margin, you borrow money from Investor’s Edge to finance part of the purchase. You’ll pay interest for the money you borrow and you’ll also need to keep the amount of equity in your account above a certain level. 

[To the right of Rob, the bar graph icon shown and beside is the explanation: “Buying 100 shares of XYZ”. Below a dollar icon with a checkmark is added, with the explanation: “Price per share of XYZ = $50”.]

[A graphic titled: “Buying stock with cash” is shown. Below to the left is: “Value of XYZ purchase”, and beside this “100 shares × $50 per share = $5,000” is added.]

Let’s use some simple scenarios to see what this all means. Let’s say you’re buying 100 shares of XYZ stock and the price per share of XYZ is $50. In scenario number 1, you pay cash for the full amount of the stock purchase. This will cost you 100 (the number of shares) times $50 per share, for a total cost of $5,000 plus commission. Very straightforward. 

[To the right of Rob the bar graph icon is shown, with “If margin rate on XYZ is 30%. Below the dollar icon is check marked and the following is shown: “Must have 30% of purchase price in account”. Below the dollar icon with the curved arrow is shown and is labelled: “Remainder can be borrowed”.]

In scenario 2, we use margin. If the margin rate on XYZ is 30%, this means that you’ll need to have at least 30% of the purchase price in your account when you initiate this trade, and it’s possible to borrow the rest of the money from Investor’s Edge.

[The graphic titled: “Buying stock with margin” is shown. To the left is the label: “Value of XYZ”, with the explanation: “100 shares × $50 per share + $5,000.” Below this is XYZ margin rate = 30%, and to the right is 30% of $5,000 = $1,500.]

[To the right of Rob is the check marked dollar icon and the following is shown: “Must have at least $1,500 in account”. Below the dollar icon with the curved arrow is shown and is labelled: “Investor’s Edge will loan remainder”.]

Let’s do the calculation. 100 shares times $50 per share = $5,000. 30% of $5,000 is $1,500. You’ll need at least $1,500 of buying power in your account to make this purchase, and Investor’s Edge will lend you the remaining amount. 

[The graphic titled: “Buying stock with margin - borrowing limit” is shown. Below is “XYZ purchase cost = $5,000”. Below is “Minimum account balance = $1,500”. Below this is “Borrowing limit = $3,500”. The amounts are highlighted and the last is circled.]

Here’s a calculation for the maximum amount that you can borrow. $5,000 is the cost of the purchase, minus the minimum amount of required buying power in your account, $1,500, equals $3,500, which is the maximum amount that you can borrow for this trade. Of course, you can borrow less, but this is the maximum. 

Interest will be charged monthly based on the average amount you borrowed during the period. The charge will hit your investment account mid-month and will either be added to the current amount you are borrowing or deducted from your cash balance.

While there are no monthly minimum payments required, the interest charged will reduce your available buying power. The interest rate is tied to our bank prime rate. You can easily check the current rate on the Investor’s Edge pricing page

Now let’s look at maintenance margin in the next scenario. It’s one week later and XYZ is now trading at $60.

[A graph titled “Buying stock with margin: maintenance” is shown. The dollar amounts on the left side start at $30 and go up to $60 by 10’s. The graph line starts at $40 and moves up and down ending at just over $50. There is a dotted line across the graph and is labelled “purchase”. As well to the right is an arrow at the $60 mark, labelled “current share price”.]

We already know that the margin rate for the stock is 30%, which means the maximum loan value for the stock is 70%. So you can borrow 70% times 100 shares times the current stock price of $60 per share. This amount equals $4,200. 

[To the right of Rob an explanation is shown using the bar graph icon, labelled “XYZ margin rate = 30%”. Below this the dollar with curved arrow appears, labelled “Maximum loan for XYZ = 70%”.]

[The graphic titled: “Buying stock with margin: maintenance” is shown. To the left is a label: “Allowable margin”, with the explanation of 70% × 100 shares × $60/share = $4,200.]

Remember that you originally borrowed $3,500 to buy XYZ and so you now have additional buying power available in your account. 

Here is the calculation based on a $60 XYZ stock price. The current allowable margin is 70% times 100 shares times $60 per share, which is $4,200. Therefore, the excess margin is $4,200 minus $3,500, which was previously borrowed, and that is equal to $700. This gives you an additional $700 of buying power, which you can either use to buy additional securities or let it act as an additional buffer in case the price of XYZ drops back down.

[The graphic titled: “Buying stock with margin: maintenance” with the same information as before. A new label is added below: “Previously borrowed” with the explanation of minus $3,500. Total is $700 and is labelled “Excess”.]

Let’s look at that scenario. One month later, there is a negative news story about XYZ and its price drops. It is now trading at $30 per share. Since its maximum loan value is 70%, you can only borrow 70% times 100 shares times $30 per share, which is equal to $2,100 based on its current price. 

Let’s recalculate your margin position based on a $30 XYZ stock price.

[A graph titled “Buying stock with margin: maintenance” is shown. The dollar amounts on the left side start at $30 and go up to $60 by 10s. The graph line starts at $40 and moves up and down ending at just over $50. A dotted line across the graph is labelled “purchase”. The graph line goes down to $30, which is labelled “current share price”.]

The current allowable margin is 70% times 100 shares times $30 per share, which is equal to $2,100. The margin requirement is $2,100 minus $3,500, which is the previously borrowed amount. That is equal to negative $1,400 dollars. This means that your account is under margin by $1,400 dollars. 

[The graphic titled: “Buying stock with margin: maintenance”. A label indicating: Allowable margin is shown to the left, with the explanation of 70% × 100 shares × $30/share = $2,100. Below is the label “Previously borrowed” with the explanation to the right showing minus $3,500. The total is -$1,400 and is labelled as “Under margin”.]

In investment terms, you’ll receive a margin call and you’ll need to deposit additional funds in your account, transfer in additional margin-eligible securities or sell existing holdings to cover your margin call. If you don’t take action, Investor’s Edge may do so on your behalf to bring your buying power back on side.

[To the right of Rob an explanation is shown titled: “When receiving margin call”. Below this is an icon of a dollar with a curved arrow, labelled “Deposit addition funds or”. Below, a  bar graph icon appears, labelled “Transfer in margin-eligible securities or”. Below this is a coin icon with arrows moving out in both directions, labelled “Sell holdings to cover call”.]

Let’s talk for a minute about the margin rate for different stocks. This rate can change without notice and can be influenced by many factors, including the stock’s volatility, current price level and other factors. 

[A graphic is shown. To the left is an icon of a coin with a % sign, labelled “Margin rates can change without notice”. To the right the following is shown: “Margin rates influenced by many factors including: Stock volatility; current price level; Other factors”.]

If the stock’s margin rate drops and your account does not have sufficient buying power, you’ll receive a margin call. Also note that if a stock that you purchase on margin goes to zero, you’re still responsible to repay the original margin loan plus interest. Just from these simple examples, you can see that there are advantages and disadvantages to using margin in your investment account. Let’s summarize the main ones. 

On the plus side. Number 1: Increased buying power. Using margin, you can borrow funds to purchase additional stocks, which increases your exposure to potential market gains.

[To the right of Rob the following listing appears, titled: “Advantages to using margin”. Below is a dollar icon, labelled “Increased buying power”. Below, a bar graph icon appears, labelled “Leverage”.]

Number 2: Leverage. Using margin gives you the ability to control a larger investment portfolio with a smaller amount of your own money. This can increase your potential returns, but losses are also magnified. 

[The graph and box icons disappear. A new icon of stacked boxes appears, labelled “Diversification”.]

Number 3: Diversification. More buying power means more opportunities to diversify your portfolio, as you can invest in different companies, sectors or industries and reduce the impact of individual stock performance on your overall portfolio. 

[Below the stacked-box icon, an icon of a scale balancing coins appears, labelled “Flexibility”.]

Number 4: Flexibility. You do not need to sell a stock to take advantage of another opportunity or wait for funds to settle as he would in a cash account. 

But there are also potential negatives.

[To the right of Rob the following listing appears, titled “Disadvantages to using margin”. Below, a red icon with an exclamation mark, labelled “Increased risk”.]

First: Increased risk. We mentioned that margin trading amplifies your potential gains, but it also amplifies your potential losses. If the market moves against your positions, your losses could exceed the amount you initially invested and that could lead to a substantial loss of capital. You should carefully assess your risk tolerance and have a solid risk management strategy in place. 

[A bar graph icon appears, labelled “Interest costs”.]

Number 2: Interest costs. As we said, when you borrow funds to trade on margin, you’re subject to interest charges on the borrowed amount. These interest costs can eat into your returns, especially if you hold the positions for an extended period of time.

[Below the graph icon, a stacked-box icon appears, labelled “Margin calls”.] 

Number 3: Margin calls. Earlier, we looked at how margin accounts require maintenance margin at a certain margin level. If your investments decline significantly, you could face a margin call which requires you to deposit additional funds or sell securities. If you don’t meet the margin call, some of your positions may be liquidated by Investor’s Edge. 

[The previous icons disappear. A new gauge icon appears, labelled “Emotional pressure”.] 

Number 4: Emotional pressure. Since losses can be magnified with margin trading, margin trading can mean additional emotional pressure. It’s important to keep a disciplined and objective approach to trading and avoid impulsive decisions driven by market volatility. 

[Below the gauge icon, an icon of a gavel appears, labelled “Complexities and regulations”.]

Number 5: Complexities and regulations. Margin trading involves various rules, regulations and borrowing conditions set by brokerage firms and regulators. It’s important to thoroughly understand the terms and conditions and the risks associated with margin trading before you do so. 

Margin trading can be a great tool to leverage your investments and increase potential returns, but it comes with an additional risk and requires prudent and disciplined management. 

Learn more about margin trading in the Investor’s Edge Learn Library. Happy trading.

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[CIBC Investor’s Edge is a division of CIBC Investor Services Inc. This document is provided for general informational purposes only and does not constitute investment advice. The information contained in this document has been obtained from sources believed to be reliable and believed to be accurate at the time publishing, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change. The CIBC logo is a registered trademark of CIBC. The material and its contents may not be reproduced without the express written consent of CIBC.]

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