Margin Accounts: Short Positions and Maintenance

The short equation

In a short account, the credit balance minus the short market value equals equity.

The credit balance is built from two sources: the proceeds of the short sale, which the firm holds, plus the Regulation T margin the customer deposits. At a 50 percent requirement, the credit balance starts at 150 percent of the short sale proceeds — which is exactly what Regulation T's supplement says for a short sale of a non-exempted security: 150 percent of the current market value.

Short 1,000 shares at $40. Proceeds are $40,000. The customer deposits 50 percent, $20,000. The credit balance is $60,000, the short market value is $40,000, and equity is $20,000.

Now the market moves. If the stock falls to $30, SMV is $30,000, the credit balance is unchanged at $60,000, and equity is $30,000 — the customer has gained $10,000. If the stock rises to $50, SMV is $50,000 and equity is $10,000 — a $10,000 loss.

The credit balance is the constant here, exactly as the debit balance was on the long side. Everything the market does shows up in equity.

Excess equity and SMA work the same way: equity above the Regulation T requirement of 50 percent of current short market value creates SMA, and a falling stock price in a short account creates it.

Maintenance requirements

FINRA Rule 4210 sets the minimum equity that must be maintained after the initial deposit.

For long positions, the requirement is 25 percent of the current market value of all margin securities held long.

For short positions, the requirement is tiered.

Stock priced at $5.00 per share or above: the greater of $5.00 per share or 30 percent of the current market value.

Stock priced under $5.00 per share: the greater of $2.50 per share or 100 percent of the current market value.

Short bonds: the greater of 5 percent of the principal amount or 30 percent of the current market value.

The per-share minimums exist because a percentage of a very small number is not enough collateral to be worth anything. Note the asymmetry they create: a short position in a $3 stock requires 100 percent of market value or $2.50 a share, whichever is greater — so shorting cheap stock is expensive in margin terms, which is precisely the intention.

Firms are permitted to impose house maintenance requirements above the FINRA minimums, and most do, particularly on volatile or concentrated positions. A customer whose account meets the regulatory minimum may still receive a house call.

Computing the call

Two questions recur, and each has a formula.

At what price does the account go into maintenance call?

For a long account, equity must be at least 25 percent of market value. Equity is LMV minus DR, so the requirement is LMV minus DR at least equal to 0.25 LMV, which rearranges to 0.75 LMV at least equal to DR, so the trigger is LMV equal to the debit balance divided by 0.75 — equivalently, the debit balance times four-thirds.

Worked example. LMV $20,000, DR $12,000. The call point is $12,000 divided by 0.75, which is $16,000. The market can fall $4,000, or 20 percent, before a call.

For a short account, equity must be at least 30 percent of short market value. Equity is CR minus SMV, so the requirement is CR minus SMV at least equal to 0.30 SMV, which rearranges to CR at least equal to 1.30 SMV, so the trigger is SMV equal to the credit balance divided by 1.30.

Worked example. Short at $40 with a credit balance of $60,000. The call point is $60,000 divided by 1.30, which is $46,153 — so about $46.15 per share on 1,000 shares. The stock can rise about 15 percent before a call.

How much must be deposited to meet a call?

Compute the requirement at the current market value, subtract the current equity, and the difference is the cash required. To meet a call with fully paid marginable securities instead of cash, deposit securities worth more than the cash amount, because their loan value is only a fraction of their market value.

Worked example. LMV falls to $14,000 with a debit of $12,000, so equity is $2,000. The maintenance requirement is 25 percent of $14,000, which is $3,500. The customer must deposit $1,500 in cash.

A customer who does not meet a call is sold out — the firm liquidates enough of the position to bring the account into compliance, and as the margin disclosure statement warns, the customer does not choose which securities are sold. Note that FINRA Rule 4210 and the exchange rules prohibit a customer from meeting a Regulation T margin call by liquidating the position, in the sense that liquidation is the firm's remedy rather than the customer's chosen method of satisfying the requirement.

Combined accounts and the specialized regimes

A customer with both long and short positions has one account with both computations running. The equity is combined; each side's requirement is computed on its own basis and the requirements are added.

An important special case the exam likes: a short position that is fully hedged carries a much lower requirement. A short sale of a security against a long position in a security exchangeable or convertible into it within 90 days is subject to 100 percent of the current market value rather than 150 percent under Regulation T. A short against the box — being short and long the same security — has essentially no market risk, and the margin rules recognize that.

Portfolio margin, permitted under FINRA Rule 4210(g), replaces the strategy-based rules with a risk-based calculation that stresses the whole portfolio across a range of market moves and sets the requirement at the largest projected loss. For a genuinely hedged portfolio, it produces a far lower requirement than the strategy-based rules; for a concentrated directional one, it can produce a higher one. It is available only to customers meeting substantial equity and approval requirements, and it requires a specific risk disclosure.

Day-trading margin has its own regime under Rule 4210(f)(8). A pattern day trader must maintain minimum equity of $25,000, which must be in the account before day trading begins, and day-trading buying power is limited to a multiple of the maintenance margin excess — four times for most equity securities. Exceeding day-trading buying power produces a day-trading call, and an account that does not meet it is restricted.

One final practical point that customers misunderstand: interest on the debit balance accrues daily and compounds into the debit. A margin position that is flat in price is losing money, and a customer holding a long-term position on margin is paying for it continuously. The credit agreement discloses the rate; the representative should make sure the customer has actually understood it.