Surviving a crash on Margin
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A few months ago, at what is now clear was the all-time high in 2021, I made the decision to switch my portfolio from a standard share account to a margin account. My reasoning was simple, I had stock that I didn’t want to sell and forgo future gains, but I wanted to do more with the gains I had made so far.
The solution I found at the time was a margin account- one where I can borrow against the value of my portfolio, (up to 50% of the value) and I used that margin account to partially purchase a house. Before we need to go further, as always, I need to clarify that this article is not investment advice. I chose a high risk, high reward strategy because I feel confident about the long term risk of my portfolio and I accept the risk of losing out if things don’t go the way I forecast. I would rather have a chance at my best-case scenario, and the cost of entry is my worst-case scenario — which I accept and can survive. You will have your own risk tolerance, and understanding that, and whether the tools used in this article are right for you, is not something that I can teach you.
I’ve previously written about my margin lending position, saying:
I did my initial math on my margin call assuming that my stock could drop from $1100 now, to $550 from before I get margin called.
So with the very recent unprovoked attack by Russia against Ukraine, and the subsequent drop in stock markets (but focusing on my personal portfolio), I saw a significant decline in the stock price of my investments, to the point where I was worried about hitting my margin limit.
My head is currently worrying about my investments, but my heart is with the people of Ukraine. It feels crass to be thinking about money when people are dying and under attack. I hope that Russia ends this invasion without further loss of life. I’m writing about this because it’s a large part of my world, but we must never forget the people that are at the heart of this crisis. As we look at the impacts on the market, please remember the human toll beyond the charts.
Looking specifically at $TSLA, After a high point in January, we have seen a steady decline driven by economic macro conditions which have affected growth stocks. This combined with the uncertainty and concern about war, resulted in a price of $700 on the 22nd of February 2022.
Now there are a few factors that go into a natural macro decline. If you normally have straight stock ownership, you can and should just hold I’ve written about the emotion at play with those kinds of decisions here and here.
However, if you have a margin account, there is a whole new worry — that you will hit your margin limit and have to sell stock. This limit is set by you based on the risk you take on, so remember when I said I was good down to $550? That means I didn’t have to worry right? Well…
After we had a decline after the all-time high of $1200, I started looking for opportunities to ‘buy the dip’, and eventually, I found buying some more share instruments, which resulted in a new margin limit of $720... That seemed pretty safe, right? We’d had a 16% drop and that would give me room for another 28% drop before I’d hit it — surely that would be enough? After all, it’s just macro depressing the share price.
The part that I forgot to take into account was a normal decline in combination with a black swan event (rare and unlikely occurrence resulting in downward market movement) could take be below that 28%, and lo, we found ourselves here.
So at $800, around about the 20th of February, it become obvious that the stock could drop below my margin limit of $720, and I needed to decide how I wanted to respond. I looked at 3 different scenarios and the possible options.
Once I did this, I then made a complicated spreadsheet to try and figure out the impact of each option. (It’s just what I do)
I basically got to the point where I found that I could have a lower ‘safe price’ with buying puts, than selling shares. (Don’t worry, we’ll talk about puts soon). Best of all, I didn’t need to sell shares, and the worst outcome of buying a put is losing the premium ($4000) vs. the worst case — Selling at $800, not being able to buy back until the share price had rebounded to $900 ($10,000).
So let’s talk about what a PUT is, how it works. And we may as well look at a CALL, because it’s opposite. These are options contracts, which is an option, to buy or sell a specific stock, in the future. This is usually a specific date, at a specific price.
Options Contracts always deal with 100 shares, so 2x Calls is talking about the right to buy 200 shares, at a certain date, at a certain price. Every Options contract will have a strike price and a strike date. So for example, you could buy a call to buy 100 shares on 20th of January, 2023 for $1100 per share.
Every options contract will also have a premium — the cost to buy that contract, which is, 100 x the price listed (because each contract relates to 100 shares). So for example, the call I mentioned above at one point at a premium of $150. The premium price + the strike price forms the break-even price, or the price at which the options contract you have purchased is profitable. So $1100 + $150 = a break-even price of $1250.
If, on the 20th of Jan, 2023, the stock is trading at $1500, you can buy the stock for $900, and sell it for $1500. Your total profit after this trade is $340 — but remember we’re talking about 100 shares, so it’s more like $34,000 profit.
The exact same thing is true of a PUT, but in reverse, you are betting the stock will have dropped to a certain point. So if the stock price is $850, you can buy a put at $800 for $20. You are betting the stock falls past $800, and if it’s below $780 (strike price + premium) then you will make the difference. Puts are a similar mechanism that people use to short a company — it’s a bet that the stock price will go down, or that the current share price is overvalued.
Are you with me so far? Because we’re about to add another thing into the mix. With a PUT, if you have a margin account, a put will reduce your margin impact. So if the put costs you $5,000, it may reduce your margin limit by $50,000. So instead of only being safe if the stock stays above $720, you may (depending on the size of your portfolio) be ‘safe’ all the way down to $620, if you have purchased a put. Why does this happen? Well basically the more the value of the stock falls, the more money you make from the put. This practice is called hedging, and it’s about offsetting the risk to your existing balance, by securing a option that will pay out if the stock drops.
One final thing to note about options contracts is that you don’t have to wait until the strike price to sell them. Like shares, Options can be bought and sold at any time, and the price of these changes all the time, in relation to the stock price. The more likely the option is to be profitable, the higher the price, and the less likely, the lower the price. However if the strike date arrives without the strike price being met, the option expires worthless, and you have lost your premium.
Here is my last complicated spreadsheet — it’s a chart to determine at what price, is buying a call more profitable than just using the money to buy shares. The higher the difference between the break even price and the share price, the more profitable the call is above buying shares.
If you’re feeling out of your depth with all of this terminology, don’t worry, I felt exactly the same way. I knew about options for years but I put them in the too complicated basket. Honestly, I still kinda feel that way. It was only recently that I finally forced myself out of my comfortable place, and with some hand holding from more experienced investors, set out to try and learn how all of this stuff works. It’s not easy, and mistakes are.
I think this is a good place to wrap up, as hopefully, you understand more of the basics of CALLS and PUTS, and how they can interplay with margin. In terms of some more specific actions I took to hedge my risk and avoid a margin call, I stayed awake until 7:30 am this past couple of days, actively trading puts calls and shares, to manage the risk from the market movement to my portfolio.
The best action I took was buying a put against TSLA for $820 on March 11, 2022 for $40. I bought this put when the stock was at $850. Buying this put reduced my margin requirements to lower my safe price all the way down to $630.
At one point, when the stock was at $700, this put was profitable by $8000. I sold this put when we hit $750, as it seemed clear that we were trending back up, and I didn’t need as much margin reduction by that point. I made a $4,000 profit from this trade, and it was probably one of the most stressful trading situations I have experienced in a while.
I’m fairly confident that had I not purchased this put I would have been margin called — though I can’t say that the loss from that would have been greater than the cost of my put if my put had expired worthless. My thinking at the time of buying the put was that if it expired worthless because the stock did not drop past $780, then at least I was spending $4,000 for peace of mind.
Will Hunter
Self taught. Not investment advice. Risk vs Reward.
