Theoretical Margin Trading Questions

Question

I am just educating myself on margin trading (I have no real desire to try it any time soon) and was wondering if you may help me with a scenario and a few basic questions to see if my logic is correct.

Scenario:

I have a margin account where I can put down 30% and leverage 70% from my brokerage (pretty standard I assume).

I would like to go long on a stock that is trading at $4.00 per share.
I put $10k into my margin account.
I purchase 8,333 shares putting 30% down ($10,000) and borrowing $23,333.
I am willing to lose $5,000 MAX. So I set a stop loss at approx 3.60 (.40 cent loss per share or roughly $3,330 dollars).

1. Is this correct? I assume if the stop loss is executed I have to transfer 3,330 into the margin account to make up for the loss.
2. What if the stock closes the day at 3.95 (0.05c loss per share) do I have settle up with $416 before end of day? Do I have to close out my entire position? Does this depend on the broker? Do I only have to close out if they place a margin call ?
3. What if the alternative happens and the stock closes at 4.05?

Thank you and please let me know if at any point I was unclear.

Answer 1

Is this correct? I assume if the stop loss is executed i have to transfer 3,330 into the margin account to make up for the loss.

No - you would receive $30k for the sale, pay off the loan and have 6,777 left in your cash account

What if the stock closes the day at 3.95 (0.05c loss per share) do i have settle up with $416 before end of day? Do i have to close out my entire position? Does this depend on the broker? Do i only have to close out if they place a margin call ?

It depends on your maintenance margin. Once your equity (the total value of your investment less the margin amount) goes below a certain percentage, you must deposit enough into the margin to get it back to the initial margin percentage.

However, it's unlikely that a 1.25% (.05 / $4) drop would trigger a margin call.

What if the alternative happens and the stock closes at 4.05?

Then you have stock that's worth roughly $33,750, you still owe $23,333 (plus accrued interest) and have a net unrealized gain of $417.

Note that if you did not use margin and instead bought $10k of stock (2,500 shares) with cash, your net gain would be only $125, and $417 = $125/.3 (where .3 is your margin percentage). It's no conicidence - the leverage multiplies your gains (and losses) inversely proportionally to the percentage that you contribute - so if you contribute 25% and borrow 75%, your gains (ans losses) are 4X greater than if you contributed 100%.