Margin Trading Accounts – Investors Buying on the Margin to Amp Up Gains

Margin trading accounts are employed by savvy investors to turn small allocations of capital into enormous profits through the use of leverage to turn a small amount of purchasing power into a substantially larger purchase. There are a number of ways this type of account is used, but don’t let the examples here close your brain to other types of trades using margin trading accounts.

The most common type of trade using margin trading accounts may be the straight options purchase. Although a traditionalist wouldn’t normally technically call this a margin trade, most brokers require at the very least minimum security margin trading accounts in order to trade options. Likewise traders sign the very same trade account agreement so I say it’s the same (enough) for me. A normal option trade happens when an investor purchases the proper to buy (a call) or right to sell (a put) shares of common stock of a company at a specified price (the strike price) on or before (American options) a specified date.
So how exactly does this create increased purchasing power for the investor? Consider the following example:
Albert and Bill each have $10000 to invest. Albert decides to buy shares of hypothetical company JCN at $100 per share. At this price he can buy most of 100 shares, as soon as he does, Albert has control of $10000 worth of JCN stock.
fx사이트
Bill on the other hand is aware of margin trading accounts and wants to buy call options of JCN stock rather than purchasing the stock itself. For simplicity’s sake let’s say Bill can purchase calls on JCN for $1 per share. Bill uses his $10000 to buy 100 contracts (a contract is for 100 shares) – so Bill now holds the proper to buy 10,000 shares of JCN.
Bill does not own any shares of JCN at this moment, however he controls a whopping $1 million worth of JCN because he holds the right to get 10000 shares (which at the present price of $100/share are worth $1million).
By taking benefit of his knowledge of margin trading accounts, Bill has generated what amounts to a 100:1 leverage position relative to Albert’s securities holdings. What will happen if JCN stock jumps to $102/share (a 2% price swing is a very possible scenario in today’s markets)?
Albert’s 100 shares now trade at $102/share, making Albert’s investment worth $10200.
Bill’s 100 contracts should now be worth about $2/share (option pricing isn’t an exact science), making Bill’s holdings worth $20000, doubling his money.

Leave a comment

Your email address will not be published. Required fields are marked *