I have a question related to stock loans industry. The so called "Put" is insurance which protects the downside. Lets say the lender had decided, before receiving the stocks to the brokerage account as collateral for the loan, that Loan To Value (LTV) is 60%. This defines how much equity does the borrower get out of his or her stock. But what I don't understand is the following: There is no way for the borrower to loss more than WHAT? More than 60% (so more than LTV) or more than 40% (remaining to full value 100%)? I'm asking what does the borrower have full protection when it comes to maximum potential loss. No way for borrower to loss more than the given equity (LTV) OR no way to loss more than the rest (40% in my example)? Thank you in advance!
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1Not following your terminology nor is it clear what your question about put protection is. Are you asking about margin borrowing from a broker and the possible losses that may ensue?– Bob BaerkerMay 14, 2020 at 20:16
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Yes but I'm having problems in understanding what is maximum that the borrower can loss: is that maximum equal to the equity received as a form of loan from the lender? Or is the maximum that can borrower loss the difference between 100% and LTV (equity)? Or something else?– Andrew0May 14, 2020 at 20:24
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The reason I'm asking this is: More research I do on that, more info I get that the answer I'm looking for may be that borrower cannot loss more than LTV % is but to me it doesn't make sense. Borrower won't return the actual loan but will only pay it so why would he loss the amount of loan (% ltv).– Andrew0May 14, 2020 at 20:31
1 Answer
In the US, the Reg T long margin requirement is 50% and the Margin Maintenance Requirement is 25% (MMR) though brokers can require more.
If your security is marginable and fully paid for, you can borrow an equal amount of its value to buy more stock. If you do so, your equity drops to 50%. If the stock goes bankrupt, the entire proceeds are gone and you owe the brokerage firm the dollar amount of the loan.
As the price drops, the amount of your equity drops, reducing the amount of margin. Your broker monitors this and will sell out your position if the MMR level is breached. This occurs when the security loses 1/3 of its value and which is 2/3 of your margin deposit. However, this isn't guaranteed in real life because if share price collapses and gaps through the MMR, you could end up losing more.
For example, you put up $5k and at 50% margin, you buy $10k worth of stock. The MMR level is 4/3 times the debit balance or $6,666.67. At that point you would have $1,666.67 of equity and on a $5,000 loan, margin would be 25%.
And yes, one could buy a long put to limit the potential loss of a margined security.
A more complex and riskier scenario is using your fully paid marginable long stock to fund the establishment of a short position in another security. Because shorting has open ended upside loss, your potential loss could be significantly more.
