Non-Marginable Securities
Securities that cannot be purchased on margin at a particular investment brokerage or financial institution
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What are Non-Marginable Securities?
Non-marginable securities cannot be purchased on margin at a particular investment brokerage or financial institution. If purchasing the securities, investors must fund their full order with cash.
Financial institutions will almost always maintain an internal list of non-marginable securities, which retail investors can find online or by contacting their broker.
The most common non-marginable securities include over-the-counter (OTC) market stocks, penny stocks, and recent initial public offerings (IPOs).
Summary
- Non-marginable securities cannot be purchased on margin and need to be funded with the investor’s cash.
- The securities exist to protect investors by reducing the risk that comes with purchasing securities with leverage.
- Non-marginable securities include penny stocks, OTC stocks, and recent IPOs, as the securities tend to be riskier due to higher price volatility and lower liquidity.
- Using margin can amplify returns but significantly increases losses when the price of the underlying security does not move in the expected direction.
Marginable Securities vs. Non-Marginable Securities
Marginable securities include equities, bonds, futures, and other securities that can be purchased on margin. To purchase securities on margin, investors must open a margin account with their broker. Such accounts typically require a minimum investment of $2,000 but allow investors to typically borrow as much as 50% of the order amount of any marginable security. The percentage can vary based on the brokerage firm, experience, and profile of the retail investor.
Margin accounts also require investors to hold a minimum cash (equity) balance in the account. The amount is known as maintenance margin and is a percentage of the total account value. For example, if the margin account comprises securities worth $60,000 and the requirement is 25%, the investor would need to maintain a $15,000 equity balance in their account.
If the investor purchased the securities with only $10,000 of their cash, the broker would trigger a margin call of $5,000. At such a point, the investor must increase cash in the account by $5,000.
In contrast, non-marginable securities cannot be purchased on margin, and non-margin accounts do not require a minimum cash balance. Non-marginable securities also tend to be less liquid and more volatile than the average stock.
Advantages of Non-Marginable Securities
The classification of securities into marginable and non-marginable securities exists to shield investors by reducing the risk associated with buying securities on leverage. The downside of marginable securities is the additional risk that comes with using leverage. While investing on margin can amplify returns, it can increase losses when the price of the underlying security moves in the opposite direction.
For example, let’s assume an investor purchases 10,000 shares of a stock trading at $10. The total amount of the account is $100,000. Let’s assume that the investor put in $80,000 of his cash and purchased $20,000 on margin. Now, if the stock goes to $6 the next day, the investor is burdened with the $20,000 loan, in addition to the loss on his capital. The total loss to the investor is $40,000.
If the investor were using a non-margin account or purchasing a non-marginable security, the loss faced would have only been the loss on the investor’s capital. The investor would have only been able to purchase 8,000 shares and faced a loss of $32,000.
Why are Some Securities Non-Marginable?
As mentioned earlier, non-marginable securities exist to protect investors from the downsides of using leverage. Securities that are generally non-marginable include OTC market stocks, penny stocks, and recent IPO listings. Such securities are put in the non-marginable category because they tend to be relatively less liquid and more volatile than the average stock. The volatility can be measured by beta and the liquidity by the daily average traded volume.
The two factors mentioned above make the investment in such securities risky because they experience extremely high daily/weekly price volatility. For example, it is not uncommon to see OTC and penny stocks move between 30%-100% in a day. Similarly, many IPOs see aggressive price volatility on the first day and in the first week of trading.
Using leverage on such securities comes with the potential to greatly amplify an investor’s losses if the stock price does not go in the expected direction. The idea behind non-marginable securities is to keep such securities from investors who tend to invest on margin.
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