Margin requirements in long/short strategies

Discussion in 'Risk Management' started by dg773, Jun 14, 2008.

  1. dg773


    My broker's margin requirements are 50% of the stock value on both long and short positions. When short positions are opened, the proceeds add to cash and subtract from equity.

    What I'm trying to understand is the arithmetic of applying these requirements to market neutral pairs. Let's say I open a long position on stock A at $10, and short stock B at $10. Net equity is zero, and my account equity would be whatever cash was in the account.

    But do my broker's requirements of 50% equity mean that I need $10 of cash for EACH such position separately opened (i.e. $5 to cover the 50% of the long side and another $5 to cover the 50% of the short side)? This seems incredibly onerous, especially in a portfolio with many such pairs (each market neutral, and collectively diversified) in the account.

    Perhaps I'm misunderstanding the way to apply the requirement?

    Thanks -
  2. Good question, dg.

    My understanding is that the 50% requirement would apply to the long position. At my broker, I would need a margin account to sell short, but the requirement does not apply because they hold the cash from the short sell until I cover.

    The only limit for shorting equity is the number of shares your Broker has available to sell short.
  3. dg773


    Thanks, Sophie, of course you're right.

    When the broker says that "short sales are subtracted from equity" it's misleading. The *shares* subtract from equity, but the cash proceeds from the sale add equally to equity (unless the cash is withdrawn).

    On a standalone basis, both the long side and the short side of the pair are equity neutral, if the cash isn't touched.

    Next time I'll have my first cup of coffee before asking a question :)
  4. dg,

    Correcting my earlier statement. Just checked with my broker. There IS a margin requirement for short positions. It varies depending on the stock.

    Some examples: For Visa (V) the short margin is 50%, for Keybank (KEY) the short margin is 70%.

  5. Yes, there most certainly is a margin requirement when you short stock. If the price goes up, the broker wants sufficient funds in your account to be able to buy the stock back. And if you can't cover a margin call, they will buy it back before you've run out of cash to do so.

    As to the original question, you'll need margin to cover both the long and short positions. The fact that there's a statistical relationship between the two is meaningless to the computer that's doing the margin calculation.
  6. AAA30


    Your margin on your short position should be 150% meaning the proceeds of the short sale 100% plus your equity margin(50%).