Margin and Exposure

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3 The advantages of trading on margin Comparing share trading with Spread Betting...06 Overnight financing costs...07 Going short Types of Spread Betting contracts...09 More examples of working out margin on shares...10 Notional Trading Requirement (NTR)...11 Your exposure and risk UK equity trade example Selected risk Deposits and margin calls...18 Liquidation orders...21 Summary Test your knowledge

4 When you place a spread bet, you will only need to deposit a small amount of money to open a position. This is known as trading on margin. When you spread bet on shares, you need to have only 3% to 20% of the total value of your bet in your account depending on your chosen instrument. For example, Tesco (TSCO) has a margin requirement of 3% but Dominos Pizza (DOM) has a margin requirement of 20%. All other spread bet products are traded on a notional trading requirement (NTR) which is a fixed number. For example, the NTR on the UK100 is 50, and if you wanted to buy at 1 a point, you would need 50 (50 x 1) for margin in your account.

5 The advantages of trading on margin 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. 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. In the back of Trading IQ is a pull-out of our most popular NTRs for easy reference Margin can be like a double-edged sword, working for you in positive positions and against you in negative positions. 5

6 Comparing share trading with Spread Betting 6 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 to sell and to buy. The slightly higher price takes into account our increase in the spread Traditional stock broker Spread Betting company Buy price pence pence Initial outlay (3% of ) Commissions 5* In Spread Stamp duty 5 None Total outlay * 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 and you decide to sell at this point. The slightly lower price takes into account our increase in the spread Traditional stock broker Spread Betting company Sell price pence pence Initial profit (19.24 x 2 a point) Commissions 10 ( 5 x 2)* In Spread Stamp duty 5 as before None Overnight Financing None Total Profit Total profit minus 18% Capital Gains Tax** This is the total exposure of our spread bet, pence multiplied by 2 per point = Remember spread bets are Capital Gains Tax free** (explained on 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 of the spread.

7 Overnight financing costs 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 x 2 a point = x 8.00% (LIBOR* + 3%) = 80 divided by 365 (days in the year) gives you a financing cost of 0.22 each night. 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. *Using a LIBOR rate of 5.0%. 7

8 Going short 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 x 2.0% (LIBOR* - 3%) = 20, divided by 365 (days in the year) gives you a credit of 0.05 each night. If we still look at our BP example, and you had decided to go short (sell) at for 2 per point, once again your total exposure would have been You then multiply your total exposure ( 1000) by LIBOR - 3%. 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. However we do offer you two different spread bet contracts. Let s have a look at the different types of spread bet contracts you can choose from. 8 *Using a LIBOR rate of 5.0%

9 Types of Spread Betting contracts 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. 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. 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. 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. At the start of each contract three months financing charges, fair value and some market sentiment are built into the price. Both the Daily Rolling Cash bets and quarterly bets can be closed out at any time and are automatically rolled over. So, they will continue to run to the next day or the next quarter until you close them out. 9

10 More examples of calculating margin on shares bets Here is another example of trading stocks on margin. Suppose you wanted to buy (go long) BHP Billiton (BLT) 2 per point at How much margin would you have to put forward to open the position? The share price to buy is multiplied by pounds a point ( 2) = 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% = 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. 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% European and US stocks 5% You can have as many open positions as you require, as long as you have enough free equity to cover your margin requirement. 10

11 Notional Trading Requirement (NTR) 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. UK US GERMAN30 40 FRENCH40 30 GBPUSD 150 EURUSD 150 XAUUSD (gold) 30 US Crude 140 Note: NTRs are subject to change Questions 1. If you wanted to buy (go long) 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 = If you wanted to sell (go short) Gold at for 2 per point what would your margin requirement be to open this position? You still would only have to put forward the NTR (30 points) multiplied by your stake per point ( 2) = 60 to open the position. 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. 11

12 Nothing happens until I make it happen. Scott Wilson

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14 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 The total exposure of this trade would be 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. Let s take a look at a UK equity trade as another example. 14

15 minimise risks. UK equity trade example Suppose you want to trade British American Tobacco (BATS) at 1 a point and it is currently trading to buy at Your total exposure would be 1800 (1800 x 1 a point). We will explain in Module 3 how stop losses and guaranteed stop losses can limit your potential losses. The level of risk on this trade will be the same as if you bought 1800 worth of physical stock. If BATS dropped from 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. These are essential if you want to 15

16 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 If the US30 goes down to you would look to close out of your position at a loss but if it increased to 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 falls, as you are long on the physical assets and short on the spread bet. 16

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18 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: 1. Close or reduce one or more of your open positions to reduce your initial margin to the required level 2. Deposit additional funds into your account. Because of the volume of clients, margin calls are usually made via . 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 PRU has a margin requirement of 5%. The margin you require for this position is just 300. This is ( x 10 a point) = 6000 x 5% margin = 300 Your account may now look like this. 18

19 If this falls to 0 you will receive a margin call . 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. If the free equity falls below zero, the green bar will become red. When your account falls to this level you will be on margin call. 19

20 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 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 this debt of 85. 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. 20

21 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. Ideally we don t want our clients to fall into debt, so when your total equity falls to less than 100 or 20% of your total margin (whichever comes first), we will normally liquidate one or more of your open positions. Please see our Terms of Business for more information. 21

22 Now you should be able to: P P P P Understand the different margin requirements Calculate your margin requirements across all our instruments Calculate the total exposure on each trade that you do Understand risk/reward and know the procedure for margin calls and the situations leading to them 22

23 1. If you wanted to go long (buy) Stock ABC at for 2 a point and the margin requirement is 5%, what would your initial margin be? 2. What would your initial margin be if you wanted to go short (sell) Gold at at 3 a point? Test your knowledge Try to answer as many questions as you can and then turn to page 26 for the correct answers. If you were trading a US stock, what overnight rate would you be charged if you held the position after 10pm UK time? If you are short on an equity overnight do you pay or receive financing? 5. What does NTR stand for? What is the NTR for the UK100? What is a good risk reward ratio to use when you first start trading? 8. What is your total exposure if you are buying BT at for 5 a point? 23

24 Notes and calculations on margin and exposure 24

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26 7. At least 2:1. Answers for page x 2 per point = 3804 total exposure multiplied by the 5% margin requirement equals The NTR for Gold is 30 points, 30 multiplied by 3 equals 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. 8. The share price of multiplied by 5 per point equals 1050 total exposure. 26

27 We hope you found this module useful and interesting. If you want to know more then contact one of our educational advisers on Or visit cmcmarkets.co.uk/education for more details of our seminars on the subject. Risk Warning Remember Spread Betting is a leveraged product and carries a high level of risk to your capital. It is possible to incur losses in excess of your initial stake. Spread Betting may not be suitable for everyone, so ensure that you understand the risks involved and seek independent Margin advice and Exposure if necessary. 27

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