Margin buying and short selling
◈ 13 cardsBorrowing to buy and borrowing to sell — the P&L on a long with commissions and a dividend, the equity, margin percentage, call price and call amount on a margined purchase, the leverage effect, and a short sale including the dividend the short seller pays.
Trade 1 — a plain long
Ossington Brewing's treasurer buys 400 Tamarack at $25.00, receives a $0.30 dividend, and sells at $28.50; the dealer charges $9.99 each way:
=(28.5-25)*400+0.30*400-2*9.99 = 1,400 + 120 − 19.98 = 1,500.02
On a cost of 10,000, a return of 15.00 %. Commissions and dividends are the two lines students drop; the paper includes both.
Trade 2 — buying on margin
She buys 1,000 Lakehead at $40.00 — 40,000 — but the dealer lends part of it. This dealer requires 50 % margin on the purchase and 30 % maintenance (the prompts state the rates; do not assume a regulator's schedule). She puts up 20,000 and the dealer lends 20,000.
The loan is fixed; the equity floats. Every margin quantity is , and the margin percentage is equity over market value:
| Price | Market value | Loan | Equity | Margin % |
|---|---|---|---|---|
| 44 | 44,000 | 20,000 | 24,000 | 54.5 % |
| 40 | 40,000 | 20,000 | 20,000 | 50.0 % |
| 32 | 32,000 | 20,000 | 12,000 | 37.5 % |
| 28.57 | 28,571 | 20,000 | 8,571 | 30.0 % ← call line |
| 27 | 27,000 | 20,000 | 7,000 | 25.9 % |
At 32: =32000-20000 = 12,000; =12000/32000 = 37.5 % — still above 30 %. The margin-call price is where equity is exactly 30 % of value: , so
At 27 the account is under the line; the call is the cash that restores 30 %: required equity =0.30*27000 = 8,100, actual 7,000 — deposit 1,100. Fail to meet it and the dealer sells shares.
Leverage. At 44 the stock is up 10 % but her equity is 24,000 on 20,000 — up 20 %: =(44000-20000)/20000-1. At 36 the stock is down 10 % and her equity down 20 %. Margin doubles the percentage move both ways (the loan's interest, ignored here, makes the real figures slightly worse).
Trade 3 — a short sale
She expects Maritime Ferries to fall. She borrows 500 shares through the dealer and sells them at $36.00; the 18,000 proceeds are held by the dealer as collateral, and she posts margin on top. Maritime goes ex-dividend at $0.40 while she is short — the lender of the shares is still owed that dividend, so she pays it. She buys the shares back (covers) at $31.00 and returns them:
=(36-31)*500-0.40*500-2*9.99 = 2,500 − 200 − 19.98 = 2,280.02
Had Maritime risen to 42: (36 − 42) × 500 − 200 − 19.98 = −3,219.98 — and nothing stops it at 42. A long position's loss is capped at the price paid; a short's is unlimited, which is why a stop-buy order (Lesson 11.7) sits above every short. Three obligations: return the borrowed shares (the lender can recall them — a buy-in), pay any dividends while short, and maintain margin as the price moves.
Recompute
Maintenance 35 % instead: call price =20000/(1-0.35)/1000 = 30.77; at 27 the call is =0.35*27000-7000 = 2,450. Cold: margin-call price = loan ÷ ((1 − maintenance) × shares).