Margin products are complex financial trading types, that we will explain on this page. How they work, what they include, and which types exist will all be covered. Before we begin, do note the disclaimers and complexity involved in trading margin products.
Margin products explained
Margin products are a form of borrowing. As the client, you are the borrower, and your product provider is the lender. This is usually a broker. In order to make your trade, you borrow money from them to finance part of your purchase. Your minimum cash payment for a margin transaction is called a margin deposit or margin requirement.
Your product provider sets the amount of your loan (called an exposure), as well as the leverage and interest rate on your loan. You can speculate on price movements in either direction. Unless you have enough money in your account to buy outright (meaning without using borrowed money), you must use margin products to participate in this market. This is entirely optional though, and alternatives on investing products might be more suitable.
More on leverage
In the financial world, leverage refers to how much “bang” you get for your buck. Leverage can increase returns, but it also increases risk. Imagine a fisherman who owns a small boat carrying her out to the fishing grounds every morning. This is an example of no leverage: she owns one boat and spends one day on the ocean each day. Now imagine she uses some of her profits from her fishing business to buy a second boat and hires someone to operate it for her. The amount of profit she earns has doubled (or more) because she has two boats instead of one, but any risks associated with owning that second boat are also now twice as high (or higher).
Leverage is often expressed in terms of a ratio: for example, 5:1 means every dollar invested is matched by five dollars borrowed; 10:1 means ten dollars borrowed per dollar invested; etc. The higher the leverage ratio, the greater potential returns become — but the greater potential losses become too. It’s important that you understand leverage before you engage in margin trading or borrow money to invest since leverage can magnify both wins and losses!
Disclaimers and their importance
- A risk warning is a reminder that the customer should read and understand before trading. It’s important because it outlines the risks associated with trading margin products.
- Leverage. This means a customer can trade large amounts of money for a relatively small deposit for initial investment. With leverage, there’s more potential for profit as well as potential losses, so customers need to be aware of this and manage their funds accordingly.
- Examples: Please note that there are inherent risks involved with trading financial products, including but not limited to market volatility, interest rate movements, currency fluctuations, and other factors which may affect the value or price of a derivative product. The risks may be enhanced if the customer uses high levels of leverage or employs strategies such as ‘buy-writes’, ‘straddles’ or ‘synthetics’. Past performance does not guarantee future results.
Margin products 1: CFDs
CFDs are flexible instruments, meaning they provide you with a range of ways to trade. CFDs can be traded in multiple units. With CFDs, you can buy as many or as few contracts as you wish, subject to the minimum ticket size for each contract. This flexibility means that you can tailor your position size precisely to match your risk appetite and trading strategy. In addition, the level of margin required when trading CFDs is much lower than would be the case if you were required to buy an equivalent amount of stock in the market outright.
There are essentially two types of margin accounts: cash and securities (or “margin”). The difference between them is what happens if your account falls below a certain level (known as “minimum maintenance requirement”). If it does, we’ll liquidate some or all of your positions in order to bring it back up above the minimum maintenance requirement. With a cash account, this liquidation takes place immediately; with a securities account, there’s a two-day grace period during which time it may be possible for you to reverse the situation by depositing further funds into your account or selling existing positions.
Margin products 2: Forex
Forex, or foreign currency exchange, is a form of margin trading. The forex market is the largest and most liquid financial market in the world with an average daily turnover of $5 trillion. It trades 24 hours a day and seven days per week, meaning you can always find someone somewhere to buy or sell your currency pair —even if the market is closed for the weekend!
Here’s an example trade on forex: Let’s say that you’re interested in buying 1 unit (1 lot) of EUR/USD at 1.2345 as you believe that it will go higher against the USD. This means that for every $1 USD represented in your account balance, you’ll be able to buy €0.8053 EUR.
Below, you can see a snapshot of live prices for Forex Pairs.
Margin products 3: Options
Options are a type of derivative, which means that the price of an option is based on the price of another security (the underlying security). Options are contracts that give you the right to buy or sell shares at a specific price for a specific period of time. You can use options as a hedge against risk in your portfolio.
Options are usually traded on exchanges, such as the Chicago Board Options Exchange, where rules and regulations help ensure that their trading is conducted in an orderly manner. When you buy an option, you have to pay a premium – the option’s cost – but you don’t need to make any other investments at that time. If you decide not to exercise your option during its contract period, it expires worthlessly. As with other forms of securities trading, there is significant risk involved in options trading, especially if you’re new to it.
Below shows an example of an options auction
Margin products 4: Warrants
Warrants are a type of option, and they allow you to speculate on the direction of a stock price by offering some leverage. Like options, warrants are issued by banks and listed on an exchange. Warrants give you the right (but not the obligation) to buy or sell a security at a fixed price in the future.
For example: If a bank-issued 100,000 warrants to buy IBM at $100 with an expiration date six months from now, then that means there are 100,000 outstanding contracts for people who hold those warrants. These holders can exercise their rights if IBM is trading above $100 at expiration, giving them the ability to convert their warrant into equity at a discount to its market value.
The potential upside is enticing for investors who believe that IBM will trade higher than $100 in six months’ time: They can enter into this contract for less money than it would cost them to buy shares in IBM outright and potentially make more money on each share if they’re right about IBM’s future performance. However, if IBM is trading below $100 when expiration hits and you decide not to exercise your warrant, it expires worthless since you would have no reason to exercise your right when there’s another way of making money as an investor — selling short.
Margin products 5: Turbos
A turbo is a financial derivative product. It is also similar to the option, but it limits your possible losses.
If the underlying price at the time is higher than the strike price, then there will be a positive payoff; otherwise, there will be no payoff. Note that there are no negative payoffs in this situation: in other words, you can never lose more money than your initial investment with this type of option.
Turbo options are also leveraged products: they have high implied volatility relative to their notional value. This means that when the market moves up or down by 1%, a turbo may move up or down by 3-5%. This makes them risky investments because even though they’re much cheaper than regular options, they react very strongly to any changes in market conditions. Turbos are also designed so that if you hold them until expiry (the date on which they stop being traded), then your payoff will always be close to zero–this makes sense because if you think about it for any stock or index, it’s pretty unlikely for its price to move up or down dramatically over short periods of time. This means that turborallies and turboplunges tend to happen when investors don’t think things through and buy these products without understanding how they work.