Saturday, December 01, 2007

Another margin call!

It is getting annoying the margin maintenance rules of eTrade: I have an investment system for AMD, that believe it or not, every time I make lots of money, I get a margin call!

It has to do with the margin rules. In eTrade, as many other brokerages, the shares you own may be used as collateral for the margin loan, that is, the guarantee you give of being able to pay your margin balance are the shares themselves. Nevertheless, options can not be used as collateral, then, if for some reason you gain lots of money on options while you lose comparatively less on shares, you may lose "margin equity" and get a "margin call". This has happened to me so often that I lost track of the number of times.

My investment system is not very easy to describe, so be prepared to read this several times: I write short term at-the-money covered calls, meaning that I sell calls of strike prices close to the current stock price to expire in a few weeks backed up by shares, but in reality, I use the covered calls as a hedge and money flow to pay for the real investment, quantities of very long term and far-out-of-the-money puts. Since I gain either way with the shares moving up or down (or even more when they move sideways, yeah, I am like the casino: "The House Always Win") I go full tilt with margin purchases, and when I say "full tilt" I mean that I really buy everything I can buy on margin [ note: there are a number of adjustments that I do that may imply acquiring calls or other complicated plays against the market or bullish the market, but the bottom line are the written covered calls with shares overprotected ].

Anyway, when AMD crashes, as it happened recently, those puts really appreciate, much more than what I lose on the shares (the gains on the written calls are not significant in this case); but since the puts do not count towards margin equity, I get a margin call, and typically it forces me to sell a chunk of long term puts, which pisses me off 'cos I have to make sure that the order gets executed the margin call day and so I get hit with the bid/ask spread that may be huge in highly volatile environments...

Fortunately, this time I really wanted to reduce my AMD positions because half the downward movement I expected to happen in 2007 already happened, so, the next half is not so clear: I am not so sure that AMD will go below $7 now that it is @$10, not with the same conviction I had when it was at $13.50 that it will go below $10. I could, in principle, "neutralize" the position to not speculate on whether AMD will appreciate or not with the intention to just "milk" the written calls at over 1% per month of total gains including margin interest and all; but I think I can give my money better use. All in all, I sold 1/4 of my AMD positions and I am now 1/2 as bearish as I was before.


Khorgano said...

Howdy, I just discovered your blog and thought I'd say hello.

I can see why you're frustrated with eTrade. I would certainly understand a margin call if you were writing naked calls, but the fact that you have the shares to back them up, I don't know why they'd be overly concerned about you covering the margin unless you had a low account balance or something... Anyway, your trading strategy is rather intriguing, it seems to be a rather robust long-term hedging strategy with relatively few downsides. As long as you don't mind missing out on the occasional big rallies, it should more than likely bring a steady return.

Eddie said...

I don't know why they'd be overly concerned about you covering the margin unless you had a low account balance or something...

This is not done by a broker or anything, but a computer with a simple algorithm. On the other hand, I routinely trip the conditions of margin call because I use up all my margin possibilities.

Anyway, your trading strategy is rather intriguing, it seems to be a rather robust long-term hedging strategy with relatively few downsides. As long as you don't mind missing out on the occasional big rallies, it should more than likely bring a steady return.


Tim said...

I just found your blog. E-Trade's margin calls are insane at best.

I am just a random leisure investor that maybe puts in $1,000 at a time into low-priced stocks that I feel have a future. I always do it in cash... have never used margin trading at all, but signed up for it in ignorance a long time ago thinking I would use it one day if I had a stock perform really well or when I built up my portfolio.

Lesson learned. One of my stocks has dipped over the past few todays, and today I wake up to find that E-Trade has depleted my account balance to cover a "supposed" margin debt even though I have never purchased one share on margin. I understand that's not quite how the system sees it, but it's frustrating nonetheless.

I have read a couple other people say that they had similar issues, and it self-corrected after a few days... but I don't know. We'll see what happens, if it was a legit margin trip or a systematic screw-up.

Bad thing for me is that because of E-Trade's awesome interface and excellent customer service, I have used my brokerage account as my bank account for the past year or so since my old local bank was so bad.

Lesson learned there, too. First thing I am doing when this gets resolved is opening a E-Trade checking account to keep my must-have money separate from my trading balance..... second thing is having the damn margin trading removed! Thank God for my savings and Global Currency holdings there or I would be broke! LOL

E-Trade is great, they just have a few idiosyncrasies you have to get used to.

Eddie said...

Tim, do you actually like eTrade? I find their customer service the worst of the worst I've ever come across...

ZFusion said...

I just created a margin account and started doing some searches as I got a Margin Call of $19,097. I deposited about $6,500 into the account and made a few quick day trades in the past week. On impulse I made a stupid decision to buy something that dropped 20%. I only used 3,500 to purchase that stock.
I used another 3000 to purchase something that went up 40% on some good news last night which will be sold when the market opens.

I am totally confused how margin accounts work. After first reading about them I was under the impression that I could play with more than $13,000 since I deposited $6,500 however I found that I could only purchase with what money I had deposited.

One thing I have learned is to never make another sell order that lasts for more than the day as I was unable to sell something until the market opens the next day.

I will be really pissed if Etrade forces me to sell off the shares that dropped in price as I deposited another $2000 into the account and will sell the other stock at a profit. But I don't have the funds to drop another $13,000 into the account.

I feel like the margin account is no different than a cash account except for the fact that you can make more trades, however holding a stock more than a day may end up in creating some insane margin call of more than 3X the cash you started with.

ZFusion said...

Just figured out what happened to me was that I traded a single stock 4 times within 5 days. Buy, Sell, Buy, Sell. 4 Trades and now I am considered a pattern day trader which requires $25,000 balance. Luckily I had the money so my account didn't get locked for 90 days. New to all this trading...

Fabio said...

Investigation of E*Trade’s Margin Practices

The law firms of Moody & Warner, P.C. (Chris Moody and Repps Stanford) and Nicholas & Butler, L.L.P. (Craig Nicholas and Alex Tomasevic) announce an investigation into E*Trade Financial Corp. and related companies, including E*Trade Clearing, LLC.

Our investigation seeks to determine whether customers of E*Trade, particularly options traders, have experienced any of the following:

incorrect margin balances/buying power calculations by E*Trade

incorrect margin calls by E*Trade

improper options contract assignments and/or failure to deliver

lost trading opportunities due to incorrect margin balances

forced liquidation of account assets by E*Trade to meet erroneous margin calls

Actions of these types by E*Trade may violate one or more of E*Trade’s legal obligations to its clients, including obligations imposed by California consumer statutes. If you have experienced one of these actions and have suffered losses as a result, you may be entitled to compensation. If our investigation confirms that these problems were sufficiently wide-spread, a class action lawsuit seeking compensation may be filed.

If you have information on any of these issues we want to hear from you!

Eddie said...

Very interesting comment, Fabio