Pledging of Shares for Trading/InvestingPLEDGING OF SHARES/SECURITIES FOR TRADING/INVESTING
BACKGROUND
A “pledge” means something given as a security against an obligation extended by the recipient of the pledged security to the person who owns the security. For example, A pledges 100 shares of Company X valued at INR100,000 to secure a loan of INR75,000.
In the above case, there may be an interest element as well depending upon the type of the arrangement that the borrower and the lender have agreed upon.
In the world of stock markets also it is possible to pledge the shares owned/held by a person to obtain additional margin against the shares/specified securities that have been pledged. In the above example, if A wanted to have additional margin to trade by placing his entire holding of 100 shares, he may receive say INR80,000 as collateral funded margin. There is a reduction of 20% which is known as a “haircut” or safety margin applied by the lender.
The readers may find more details about it on the websites of the respective brokers.
INTENT
The intent of this article is to share my thoughts on the purposes for which pledged securities could be traded. Based on my reading on the Zerodha support portal, I could not find how long pledging the securities is possible. As such I assume that there is none. Of course, there will be Risk Management time limits, but that is beyond the intent of the article.
Based on my reading it appears that against the pledged securities, one can obtain margin for the following only:
Intraday Equity Trading
Long Futures contract
Short Futures Contract
Options Writing or Selling of Options
The above clearly indicates that anyone who is pledging his/her securities should be clearly aware about the associated risks and should be at least partially active trader if not a full time trader.
The question that I have is:
Why should I not be allowed to buy equity shares or ETFs of non-pledged entities within the overall margin made available to me?
Trading/Investing as such carries its own set of risks so any trading that is funded by pledging would also attract a similar or even greater element of risk. It is common knowledge that the risk factor or the quantum of risk increases if the trade that is undertaken is leveraged as against a purely non-leveraged trade. Let me explain this by way of some examples.
Collateral Margin Available: 100,000
Ledger Balance Credit Available: 75,000
As per SEBI regulations, for the purposes of trading against margins for Futures and Options contracts, at least 50% of the funds requirement should be made available by way of credit from the ledger.
The lowest margin required for Jan 2022 Futures contract is in Nestle - 86,926 or say 90,000. The lot size is 25.
My Collateral would get adjusted on account of price variations and even Marked to Market or MTM would also be impacted with every move in the price of the future.
Assuming the future moves down by 100 points, i would be down by 25*100 or 2,500. So my MTM would be -2,500. I must ensure that I have sufficient credit in the ledger to take care of the MTM variations.
As against this, consider the scenario where I choose to buy Equity Shares of Nestle, Based on the CMP of 19,400, I would be able to buy only 5 shares from out of the available margin. This means my exposure and risk is down by 80%! 5 shares against a lot of 25.
However, the current process does not allow me to go long on shares and instead, it makes me choose in line with the options given above. I am fine with intraday equity as an option for trading, but what is the logic in allowing me to trade in leveraged products that carry far greater risk and not in less risky equity shares.
If you consider the example of Options Writing, then it is even worse as sometimes, Call/Put prices could go through the roof and could put the entire capital of the trader in danger.
Then comes my final point - On what logic a Writing of Options is allowed which carries far greater risk than Option Buying which has a limited risk?
Some more questions:
Why is SEBI comfortable with this kind of a situation? Is SEBI protecting the interests of the retail traders/investors by not allowing equity shares, but allowing Futures & Options trades?
Why are not brokers not bothered about this?
Is this because leveraged products would give them a better revenue stream than the equity?
Why are we retailers so silent about this?
I would be happy to receive feedback from the fellow traders/investors, who would like to use the pledge facility by paying a nominal charge to earn incremental income from the markets and not from the view point of making a fortune out of the trades undertaken using the pledging facility.
Happy Trading/Investing,
Umesh
29-12-21
