Margin and Exposure

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Margin and Exposure

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3 The adv antages of tr ading on margin . . . . 05 Comparing shar e trading with Spr ead Betting . . .. . . . . . . 06 Overnight f inancing c osts . . . . . . .. . . . . . . .. . . . . . . .. . . . . . 07 Going short . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . 08 Types of Spr ead Betting c ontracts . . .. . . . . . . .. . . . . . . .. . 09 More ex amples of w

orking out margin on shar es . .. . . . . 10 Notional T rading R equirement (NTR) . . . .. . . . . . . .. . . . .11 Your exposur e and risk . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . 14 UK equity tr ade example . . . . 15 Selected risk . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . 16

Deposits and margin calls . . .. . . . . . . .. . . . . . . .. . . . . . . .. . 18 Liquidation orders . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .21 Summary . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. 22

Test your kno

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Margin and Exposure

When y ou place a spread bet, yo u will o nly nee d to dep osit a sm all amou nt of mone y to ope n a pos ition. T his is kn own as t rading on margi n. When you

spread bet on shares, y

ou need to ha

ve only 3% to 20% of the total v alue

of your bet in y

our account depending on y

our chosen instrument .

For exam

ple, Tesc

o (TSCO) has a margin requirement of 3% but Dominos

Pizza (D OM) ha s a margi n requir ement o f 20%. A ll other spread bet pro ducts

are traded on a notional tr

ading requirement (NTR) which is a f ixed

number

. For example, the NTR on the UK100 is 50, and if y

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Margin and Exposure

If a spread bet on a share only needs a 3% initial margin, for every £1 of cash you invest the profit or loss will be multiplied by a factor of 33. Other spread bet products such as indices, sectors and foreign exchange have a margin of less than 1% which means the leverage (the factor the profit or loss is multiplied by) will be more than 1:100. Leverage magnifies your profits and losses so it can be positive if you are in profit or negative if you make a loss.

The advantages of trading on margin

Consider this example

You have £1000 that you want to use to trade on the stock market. You have decided that you want to invest the £1000 in a position on BP. Through a traditional stockbroker you would have to put forward the whole £1000 plus stamp duty (currently at 0.5%) plus dealing commission. If you wanted to take a £1000 total position using a spread bet on BP, you only have to put forward 3% plus the extra spread, 3% of £1000 is just £30. Remember that the profit or loss you can make on this spread bet are the same as if you actually had £1000 worth of BP shares. Let’s look at this in more detail.

Margin can be like

a double-edged sword,

working for you in positive

positions and against you in

negative positions.

In the back of Trading IQ is a

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In this example we are going to compare share trading vs Spread Betting, by buying 200 shares in BP and an equivalent spread bet which is £2 per point on BP.

BP is trading at 499.50 to sell and 500.00 to buy.

* Commissions vary from stockbrokers; we have used £5 as an average. ** Tax laws can change.

The following day BP goes up by 20 pence to 520.00 and you decide to sell at this point.

Comparing share trading with Spread Betting

Traditional stock broker Spread Betting company

Buy price 500.00 pence 500.37 pence

Initial outlay £1000 £30.02 (3% of £1000.74) Commissions £5* In Spread

Stamp duty £5 None

Total outlay £1010 £30.02

Traditional stock broker Spread Betting company

Sell price 520.00 pence 519.61 pence

Initial profit £40 £38.48 (19.24 x £2 a point) Commissions £10 (£5 x 2)* In Spread

Stamp duty £5 as before None Overnight

Financing

None £0.22 (explained on next page) Total Profit £25.00 £38.26 Total profit minus

18% Capital Gains Tax**

£20.50 £38.26

There are no seperate commissions to pay on

spread bets. Instead there is a slight increase in our spreads compared to the

underlying market. For UK100 shares, we add 0.075% onto either side of the spread.

The slightly higher price takes into account

our increase in the spread

This is the total exposure of our spread bet,

500.37 pence multiplied by £2 per point =

£

1000.74

Remember

spread bets are

Capital Gains

Tax free**

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*Using a LIBOR rate of 5.0%.

When you hold a spread bet position overnight there is a small financing charge to pay because you are trading on margin and not paying for the shares in full. This is similar to a mortgage where you buy a house with money borrowed from a bank using a small deposit and pay interest back in return. As you are in effect borrowing money from us just like a bank, we charge our clients a cost of borrowing. This is an overnight financing cost you are charged each night you hold a long position open (you have bought). We charge our clients the London Interbank Offered Rate (LIBOR*) + 3% each night.

If we assume the LIBOR is at 5.0% at the moment, adding 3% gives you an annual financing rate of 8.0%. We will apply this rate to the total exposure of each position you are long (you have bought) after 10pm UK time each night. In our previous BP spread bet example the total exposure is 500.00 x £2 a point = £1000 £1000 x 8.00% (LIBOR* + 3%) = £80 divided by 365 (days in the year) gives you a financing cost of £0.22 each night.

Overnight financing costs

It is also worth

noting that when you

are short

(

you are selling)

we pay you interest.

Let’s look at that in more

detail on the next page.

There are no seperate commissions to pay on

spread bets. Instead there is a slight increase in our spreads compared to the

underlying market. For UK100 shares, we add 0.075% onto either side

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If you have a short position on (you have sold) a particular share with the Daily Rolling Cash® bets, we pay you interest for every day you hold the position after 10pm each night.

If we still look at our BP example, and you had decided to go short (sell) at 500.00 for £2 per point, once again your total exposure would have been £1000. You then multiply your total exposure (£1000) by LIBOR - 3%.

Going short

£1000 x 2.0% (LIBOR* - 3%) = £20, divided by 365 (days in the year) gives you a credit of £0.05 each night.

*Using a LIBOR rate of 5.0%

Remember we do not debit or credit you with any overnight financing costs if you close out of your positions before 10pm UK time each night.

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However we do offer you two different spread bet contracts. Let’s have a look at the different types of spread bet contracts you

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1. Daily Rolling Cash®

The Daily Rolling Cash® bet has our narrowest spread and is the best contract to trade if you plan to hold a position that you are long (you have bought) for the short term.

Types of Spread Betting contracts

2. Quarterly bets

If you want to hold an equity spread bet for the medium term and you don’t want to have to keep paying the interest each day, we suggest that you use our quarterly spread bet contract.

This spread bet has a slightly wider spread than the Daily Rolling Cash® bet, but we have built all the overnight financing charges into the price at a discounted rate.

The quarterly spread bets run for three months from March, June, September and December, although you can close them out at any time.

At the start of each contract three months’ financing charges, fair value and some market sentiment are built into the price.

As each day passes, the quarterly spread bet price will come closer to the Daily Rolling Cash® bet until it expires. It can be possible that the price of the quarterly bet is lower than the rolling cash price just before it expires.

_{Both the Daily Rolling}

Cash

_®

_{bets and quarterly}

bets can be closed out at any

time and are automatically rolled

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Here is another example of trading stocks on margin.

Suppose you wanted to buy (go long) BHP Billiton (BLT) £2 per point at 1575.00. How much margin would you have to put forward to open the position?

The share price to buy is 1575.00 multiplied by pounds a point (£2) = £3150. This is your total exposure. You then multiply your exposure by the margin you need which in this case is just 3%.

In this example the money you need to trade on margin is £3150 x 3% = £94.50.

We will take that amount, called the initial margin, out of the money you have on deposit with us. For every point movement BHP Billiton goes up in value your remaining deposit will go up by £2, for every point it goes down in value, your remaining deposit will go down by £2.

You can have as many open positions as you require, as long as you have enough free equity

to cover your margin requirement.

More examples of calculating margin on shares bets

The remaining money that is not being used is known as your ‘Free Equity’ or ‘Variation Margin’. A full list of stock margins is available in the dealing guide but as a general rule:

Top 30 UK100 3%

Rest of the UK100 5%

UK250 and small caps 10%

AIM stocks 20%

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For all other non-share spread bets i.e. indices, currencies etc, the margin requirement is a fixed figure called a Notional Trading Requirement (NTR). To calculate your margin, you multiply your chosen amount for each point by the NTR.

Here are the NTRs for some of our most popular spread bets. The rest are listed in our dealing guide and product list, available online.

Note: NTRs are subject to change

Notional Trading Requirement (NTR)

UK100 50 US30 100 GERMAN30 40 FRENCH40 30 GBPUSD 150 EURUSD 150 XAUUSD (gold) 30 US Crude 140

There are more questions at the end of this Module to test your knowledge. Now that we have covered margin, let us look at exposure and risk.

Questions

If you wanted to buy (go long) 1.

on the UK100 at £3 per point at 6200, what would your margin requirement be?

Remember with NTRs the actual traded price is not important, you just multiply your stake per point by the NTR for that instrument. In this case the UK100 NTR is just 50 points. £3 x 50 = £150.

If you wanted to sell (go short) 2.

Gold at 940.5 for £2 per point what would your margin requirement be to open this position?

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‘ Nothing happens until I make it happen.’

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Your exposure and risk

With a geared investment it is always important to consider the actual full exposure of each trade that you do and that the margin you pay is just a small deposit in relation to this.

For example, suppose you are looking to trade the UK100 Daily Rolling Cash® at our minimum £1 a point and it is currently trading at 6298/6300. You have decided that you want to buy at 6300. The total exposure of this trade would be £6300. That is 6300 x £1 a point.

The margin requirement to trade the UK100 is an NTR of 50, so 50 x £1 a point is equal to just £50. However, if the UK100 dropped in value by 200 points and you did not have any stop losses, your total loss would be £200 even though you had to put forward only £50 of your money as initial margin.

Of course, if the UK100 had increased by the same amount, you would have made £200 profit having only put forward £50 of your money as margin.

We will explain in Module 3 how stop

losses and guaranteed stop losses can

limit your potential losses.

These are essential if you want to

minimise risks.

Let’s take a look at a UK equity trade as

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Suppose you want to trade British American Tobacco (BATS) at £1 a point and it is currently trading to buy at 1800.00. Your total exposure would be £1800 (1800 x £1 a point).

The level of risk on this trade will be the same as if you bought £1800 worth of physical stock. If BATS dropped from 1800.00 to zero, your total loss on our spread bet would be £1800, which is what you would lose if you had bought the physical stock.

We will explain in Module 3 how stop

losses and guaranteed stop losses can

limit your potential losses.

These are essential if you want to

minimise risks.

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Selected risk

For most traders you have to select the right risk-reward ratio in each trade that you do.

Certainly at the beginning you should be looking for at least a 2:1 risk reward ratio. As your trading experience increases, you may feel comfortable increasing the risk element in this ratio.

For example, suppose you had placed a trade on the US30 going long (buying) at 13300. If the US30 goes down to 13250 you would look to close out of your position at a loss but if it increased to 13400 you would look close out at a profit. Most people would agree that it is worth risking 50 points to make a possible 100 points.

Another way to help reduce your risk when trading is to consider ‘Hedging’ any physical shares you may have. This allows you to protect yourself from losses in your assets by trading spread bets at a profit to offset the losses. Assume you own a physical stock (e.g. Vodafone) that you believe will go down in the near future, but you do not want to sell because you believe it is a good long-term investment, you could short it with a spread bet and earn money from its decline.

This is considered

a hedge because it

protects you if the price

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Deposits and margin calls

A common mistake that traders make when they start trading is to use up all of their free equity at the beginning and leave no extra room in case their spread bet positions go against them. Remember, the money that you use for your margin requirements is locked away until you close out of your positions, so any losses from your current open positions will come out of your free equity balance.

If you start to suffer losses from your positions and you start to run out of free equity, we could ask you to place more funds on account. This is known as a ‘margin call’.

Example of a margin call Going on margin call can happen to new traders. A margin call means you are over trading, you have two options:

Close or reduce one or more 1.

of your open positions to reduce your initial margin to the required level

Deposit additional funds into 2.

your account.

Because of the volume of clients, margin calls are usually made via e-mail. But remember, these are just notifications, it is your responsibility to monitor your positions and know when you are on a margin call.

Here is an example of how this margin debit may occur and may appear on your account. You have opened an account and deposited £500. At this point you have no open positions. You decide to buy Prudential (PRU) at £10 a point at 600.00. PRU has a margin requirement of 5%. The margin you require for this position is just £300.

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If this falls to 0 you will receive a margin call email.

We offer a graphical representation of our clients’ equity positions. A bar shows the difference between your total equity and the total margin you are using. The green bar shows the percentage of total equity that is free equity and the grey background shows the percentage of total equity that is used as margin.

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Once your total equity balance falls

below your margin

requirement, we would recommend that you place a stop loss order

with us to try to avoid your account balance falling into negative

equity. We will cover stop losses in more detail in the next chapter. The next day PRU issues a profit warning because of heavy damage in the US caused by a hurricane. This leads to a massive insurance payout, and the share price drops to 570.00. Your account now looks like the image to the right.

As your total free equity has now fallen into a negative balance, you would be on a margin call for

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Liquidation orders

When your free equity goes into a negative balance you will be on margin call. We do not normally close out your positions as soon as you go onto a margin call, but it should be used as a warning to alert you that you are over-trading.

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P

Understand the dif

ferent margin requirements

Calculate y

our margin requirements acr

oss all our instruments

Calculate the total e

xposure on e

ach trade that y ou do

Understand risk/re

ward and kno w the pr

ocedure f

or margin calls

and the situations le

ading to them

Now you should be able to:

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23 23 23 If you wanted to go long

1.

(buy) Stock ABC at 1902.00 for

£2 a point and the margin requirement

is 5%, what would your initial margin be?

What would your initial margin be if you wanted to go short 2.

(sell) Gold at 812.10 at £3 a point?

If you were trading a US stock, what overnight rate would you be charged if you held the

3.

position after 10pm UK time?

If you are short on an equity overnight do you pay or receive financing? 4.

What does NTR stand for? 5.

What is the NTR for the UK100? 6.

What is a good risk reward ratio to use when you first start trading? 7.

What is your total exposure if you are buying BT at 210.00 for 8.

£5 a point?

Test your knowledge

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1. 1902 x _£_{2 per point =}

£_{3804 total exposure multiplied by}

the 5% margin requirement equals

£_190.20.

2. The NTR for Gold is 30 points, 30 multiplied by 3 equals _£_90.

3. All overnight financing rates on equity spread bets are calculated with LIBOR+/- 3%.

4. You receive interest on short equity positions. 5. Notional Trading Requirement.

6. The NTR for the UK 100 is 50 Points. 7. At least 2:1.

8. The share price of 210.00 multiplied by

£_{5 per point}

equals _£_{1050 total exposure.}

Answers for page 23

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We hope you found this module

useful and interesting.

If you want to know more then

contact one of our educational

advisers on

0800 279 9830

.

Or visit

cmcmarkets.co.uk/education

for more details of our seminars

on the subject.

Risk Warning

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