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!
In the US, Reg T margin is 50% and the minimum margin maintenance requirement is 25% though brokers can require more.
If your security is marginable and fully paid for, you can borrow 50% of its value to use as you see fit (spend, buy more stock, etc.). Your equity is 50%. If the stock goes bankrupt, the entire proceeds are gone and you owe the brokerage firm the dollar amount 50% loan.
It's usually hard for this to occur because there is a Minimum Margin Maintenance Requirement of 25%. As the price of your security drops, the amount of your equity drops, increasing the amount of margin that you are on. Your broker monitors this and will sell out your position if the MMMR level is breached. This would mean that you would only lose approximately 2/3 your margin deposit. However, this isn't guaranteed in real life because if share price collapses and gaps through the MMMR, you could end up losing more.
For example, you put up $5,000 and at 50% margin, you could buy $10k worth of stock. The maintenance level of 25% 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 or 25%. An example of this failing would be LK which closed at $26.20 on 4/01 and had a high price the next day of $10.58, closing at $6.40. At $6.40, that's a loss of $706 more than your initial margin deposit.
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.