Last week we looked at calculating margin calls for a long account. Now let’s tackle short accounts.
Short margin accounts (SMAs) are margin accounts used for shorting stocks and are subject to the 50% Regulation T requirement. Thus, calculating a SMA’s initial margin requirement looks similar to a long margin account:
CMV + E = C
Where the current market value of the account plus its equity = total value of an account. This is similar to the long margin account calculation, but subtly and importantly different.
To demonstrate this, let’s continue with our example from last week of a $10,000 investment, now from the short side. With the 50% RegT requirement, that means we need to deposit $5,000, so our portfolio looks like this:
Deposited Cash: $5,000
CMV of Borrowed Equity: -$10,000 = Credit from Borrowed Equity: $10,000
Total Credit: $15,000
Net Equity: $15,000
Remember that borrowed equity needs to be repaid, so the CMV of borrowed equity represents a special kind of debt—as a result, we need to account for the total credit and the net equity of the portfolio (these are initially identical but won’t be for long). One way to think of this is that the borrowed shares get us $10k in cash equity but the obligation to sell those shares in the future, which is a kind of future debt whose value is unknowable. But at the time of purchase, it got us $10k.
From this perspective, we again see that the $10k in borrowed equity plus $5k in equity from the deposited cash results in a $15,000 credit to our account, fulfilling the formula we began with.
What if our bet goes against us by 20%? Now our account looks like this:
Deposited Cash: $5,000
CMV of Borrowed Equity: -$12,000
Credit from Borrowed Equity = $10,000
Net Equity: $3,000
Remember that the maintenance margin requirement for a short account is 30%, so that means this will require a $3,600 credit if the CMV is now $12k. Note also that the requirement was $3,000 for $10k. With SMAs, the maintenance margin requirement goes up with stock prices and down with LMAs.
Note also how the formulas we are dealing with look very similar, but the analysis is entirely different. LMAs can easily be calculated using a list of CMV, debt, equity, minimum requirement, and excess equity. With a SMA, we need to keep in mind the cash received upon the initial short, the CMV of the borrowed shares, and the cash position. Furthermore, SMAs carry much more risk, which is why they are often combined with LMAs. Of course, one can combine the SMA and LMA formulas in this case, but it is probably easier to do two separate calculations for the long and short sides of the portfolio (this is possible with margin calculations although it is not with all options combinations).
The rules around short accounts are in a way simpler than with long accounts, but they require a way of thinking that is not natural to most people. As a result, most analysts find they need to spend more time studying SMAs than LMAs.