Margin Requirements

The Federal Reserve sets minimum margin rules that must be followed by all brokers. Currently these rules are:

• 50% Margin on new positions
• 33% Margin on "maintenance" positions

For example, for a new position, if you purchase $10,000 of marginable stock, you can purchase an additional $10,000 of marginable stock.

For instance, if you purchase 1,000 shares of a $10 stock, using $10,000 cash in your account, an additional 1,000 shares can also be purchased on margin. Your margin debt is now $10,000, on which interest begins to accrue immediately.

This is a 50% margin because you owe $10,000 with $20,000 worth of stock in the account. If the price of the stock falls to $7.50, however, you'll now owe $10,000 on stock that is only worth $15,000. This is a ratio of 33% equity, which is the margin maintenance limit. If the stock price falls below this level, your broker may ask you to reduce your margin debt.

Marginable Stock

Not all stock is marginable. Some stocks cannot be used as collateral for borrowing margin debt.

Brokerages are permitted to set any additional rules which could be more restrictive than the Federal Reserve requirements. Most brokerages have done this for many stocks, including some Internet stocks.

Examples of additional restrictive rules are:

• Marginable stocks must have an average trading price of $5 or more for the past 30 days
• Marginable stocks must have a minimum daily volume higher than 1% of the outstanding stock
• Stocks traded on the OTC Bulletin Board system are not marginable

Rules such as those listed above are set by individual brokerages and may vary by brokerage.

Marginable Stocks Can Be Shorted

When you hold stock in a margin account, the brokerage agreement gives the brokerage house the ability to lend your stocks to other account holders who want to sell your stock short. Stock held in a cash account generally cannot be lent to short sellers. If you don't want short sellers to be able to borrow your stock, hold it in a cash account. Of course, this also means you won't be able to borrow against it.

In general, stocks that are not currently marginable cannot be shorted. When you read a post in a message board from someone who claims to have a short position on an OTC stock selling for $2, don't believe it.

The conventional wisdom is that a short squeeze can be orchestrated by moving stock held in a margin account into a cash account, or asking for shares to be issued. One reader sent us comments from a chat room where just such a coordinated effort was being planned by investors holding long positions. This is generally not possible, because brokerages are also allowed to hold, for the benefit of their short position customers, a short position in a "failure to deliver" status for an indefinite period.

There are times when brokerages are forced to close short positions in order to "balance" the books for all shares in a particular stock. But a coordinated effort among individual investors to move all shares in margin accounts to cash accounts will generally not succeed.

Calculating Your Margin Capability

Before purchasing stocks on margin, it's always wise to check what your margin capability is. This is especially true when you mix marginable stock and nonmarginable stock along with margin debt.

In general, the following principles apply:

• Only your marginable stocks count towards your margin capability.
• Nonmarginable stocks can be bought using margin, but the margin capability is drawn against marginable stocks, and the new nonmarginable stock comes without any additional margin capability.

For example, if you have $10,000 worth of marginable stock in your account (which is still the one opened $10,000 in cash), you can purchase one of the following:

• $10,000 worth of additional marginable stock, or
• $5,000 worth of nonmarginable stock

When you purchase nonmarginable stock using the margin capability of the marginable stock, any change in price of your nonmarginable stock will have no effect on your margin capability. If the nonmarginable stock doubles in price, but the marginable stock declines, you may still face a margin maintenance call.