The Margin Call - Going Long or Short?
An Investor's guide to Understanding Derivatives trading.
Hey Hisa Fan,
Here’s something to kickstart your week.
The past few weeks, we have been discussing about derivatives, and we mentioned those jargons of going short and going long.
We discovered a jackpot and decided to share it with you.
Shorting
When you're short a stock, your losses, in theory, are infinite. If the stock goes up forever, you keep losing money. Of course if your broker will usually hold cash in your account as margin.
Margin is the buffer you have to soak up losses and the margin is broken up in two parts.
(i) Initial margin - this is how much cash you need to have BEFORE you even open a position of a certain size
(ii) Maintenance margin - this is how much cash you need as the value of your position changes.
Now if you're getting hammered in a short position, your broker will expect you to have more and more cash in your account to soak up these losses.
When you start reaching critical levels where your losses aren't covered by your margin - you get that dreadful MARGIN CALL!!
That's from the old school practice where you would get an actual call saying "hey, no money here, add more or we close your position"
Have you watched the movie Margin Call?
If you haven’t definitely add this to your list of “weekend” must watch.
Going Long
If you're going long on a stock - you risk losing the amount invested. A stock price goes to zero - you lose your $100 but with shorts, you can lose much more than you invested.
So if the stock value is $100, you can end up losing everything in your account if the stock price rallies. Your gain is capped by the stock going to zero.
Long position: limited losses, unlimited gains
Short position: unlimited losses, limited gains
Now when you overlay leverage onto short positions (levered shorts), you can get hurt faster and harder. This is why you see so many blown up retail accounts across both shorts and naked options trading.
Sometimes the trade is directionally right, but because of position sizing and high volatility - positions get closed out on large price moves. Sometimes it's a single green candle that spikes for a split second - that's it - your short position is wiped out because you were heavily leveraged and exhausted your margin.
What Cowries are we collecting this week?
Nairobi Securities Exchange - Let’s collect the trade-slips from the exchange and see why the NSE posted a decline over 50% decline in turnover.
Jubilee Holdings Plc - The Jubilee-Allianz deal took effect last week, how are shareholders going to act on jubilee shares this week?
The S&P 500 - The benchmark index for the U.S stocks posted one of the worst post-pandemic weekly declines, will the decline continue?
The G20 Summit - Italy hosts G20 summit in the coming week, concerns around Italy’s stand in laborers is likely to affect companies such as Uber, Amazon e.t.c. How will it play?
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Ric Flair from BankerX dropped a few words of wisdom here.