Question

You are bearish on Telecom and decide to sell short 100 shares at the current market price of $50 per share.

a. How much in cash or securities must you put into your brokerage account if the broker’s initial margin requirement is 50% of the value of the short position?

b. How high can the price of the stock go before you get a margin call if the maintenance margin is 30% of the value of the short position?

Short answer

a. $2500

b. $57.69 or higher

Step-by-step solution

Definition

Short sale is the process of selling the stocks not owned by an investor but borrowed from broker. It is later purchased to replace the loan.

Calculation of amount to be put in brokerage account

a. Initial margin is 50% of $5,000 or $2,500.

Calculation of the price of stock to get margin call

b. Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put up for margin).

Liabilities are 100P.

Therefore, net worth is ($7,500 – 100P). A margin call will be issued when:

$7500P – 100P / 100P

= 0.30 when P = $57.69 or higher