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SMA Margin (Special Memorandum Account) – A Guide for Investors

SMA margin, or special memorandum account, is a term that investors who trade on margin should know. It refers to a type of account that holds excess margin generated from a client’s margin account and allows them to increase their buying power for securities.

SMA margin accounts are subject to certain risks. If the value of the securities in an SMA decreases, the investor may be required to deposit additional funds to their account to maintain their margin balance. If the investor is unable to make the required deposit, the broker may liquidate some of the securities in the account.

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SMA margin accounts can be a valuable tool for investors who want to increase their buying power and make larger investments. In this article, we will explain what SMA margin is, how it is calculated, and how it can be used by investors.

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What Is SMA Margin?

SMA margin is a dedicated investment account where excess margin generated from a client’s margin account is deposited, thereby increasing the buying power for the client. The SMA essentially represents a line of credit and may also be known as a “special miscellaneous account.”

SMA generally equates to the buying power balance or excess equity in a margin account. Buying power, also referred to as excess equity, is the money an investor has available to buy securities and equals the total cash held in the brokerage account plus all available margin. The purpose of an SMA is to provide additional buying power in a client’s margin account.

SMA margin exists when the margin equity in an account exceeds the Federal Reg T requirement of 50%. A Fed call will be issued against the account if the Reg T initial requirement is not met. Brokerage firms calculate the SMA balances of margin accounts at the end of each trading day to make sure they are greater than or equal to zero.

How Is SMA Margin Calculated?

SMA margin is calculated simply as the previous day’s SMA +/- the change in current day cash, and +/- the current day trades’ initial margin requirements.1 An SMA will lock in any gains realized in a client’s margin account. However, the SMA balance fluctuates.

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Consider the situation where stock within a client’s margin account realizes a capital gain and creates excess margin. If this excess amount is held in the account, and the stock position produces a capital loss at a later date, the client could then lose their gain entirely.

The SMA balance increases in value with cash deposits into the brokerage account. The SMA also holds interest and dividend payments from long positions and proceeds from closing out a securities position. Clients can use funds in their SMA to purchase additional securities for their margin account. The SMA balance decreases with cash withdrawals from the brokerage account and when buy orders for securities are executed.

Buying Power is always twice the SMA balance.

Example

A customer purchases 1,000 shares of stock ‘ABC’ on margin at $50 per share. If ABC is currently trading at $70 per share, what is the excess equity or SMA?

A purchase of $50,000 worth of securities (1,000 shares × $50 per share) requires depositing the Regulation T amount (50 percent) of the purchase. Thus, the customer equity (EQ) is original $25,000 (50% × $50,000), and $25,000 was borrowed on margin.

The long market value (LMV) has now increased to $70,000 ($70 × 1,000 shares), but the margin amount ($25,000) remains the same. Thus the EQ ($70,000 – $25,000) has increased to $45,000 and the new Reg T margin requirement would be $35,000 ($70,000 × 50%).

We calculate SMA as follows:

Current Margin requirement = 50% × $70,000 SMA = EQ – Current Margin Requirement SMA = $45,000 – $35,000 = $10,000

How Can Investors Use SMA Margin?

When the value of the securities in an SMA increases, the investor can use the increased equity to borrow more money from their broker. This allows investors to increase their buying power and make larger investments. Here are some of the ways that investors can use SMA:

To increase buying power

Investors can use SMA to increase their buying power, which allows them to purchase more securities with less money. This can be a helpful way to diversify an investment portfolio or to take advantage of investment opportunities that require a large initial investment.

To generate greater returns

Investors can use SMA margin to generate greater returns on their investments. This is because they can use borrowed money to purchase securities, which can magnify their profits if the securities appreciate in value. However, it is important to note that margin debt can also magnify losses if the securities depreciate in value.

To manage risk

Investors can use SMA to manage risk by using it to short-sell securities. Short selling is a strategy where an investor borrows shares of a security and sells them, hoping to buy them back at a lower price in the future and pocket the difference. This can be a helpful way to protect against losses if an investor believes that security is overvalued.

What Are the Risks of Using SMA Margin?

SMA margin can provide investors with more flexibility and leverage for their trading activities, but it also comes with some risks. Investors should be aware of the following potential pitfalls of using SMA margin:

SMA margin does not protect investors from market losses

If the value of the securities in the margin account declines, the equity and the SMA balance will also decline. This may result in margin calls that require investors to deposit more cash or sell securities to meet the minimum requirements.

SMA margin does not guarantee that investors can withdraw cash or buy securities at any time.

If the SMA balance is negative or zero, or if the Reg T initial requirement is not met, investors cannot use their SMA for any purpose. They may have to deposit more cash or sell securities to restore their SMA balance and meet their Reg T requirement.

SMA margin does not prevent interest charges on margin loans

If investors use their SMA to buy more securities on margin, they will increase their debit balance and incur more interest charges. They may have to pay off or reduce their debit balance with cash or securities to avoid interest charges.

SMA margin does not eliminate exchange rules or brokerage policies.

Investors should check with their broker or exchange before using their SMA for any purpose, as they may have different rules or restrictions on how SMA can be used. They may also charge fees or commissions for using SMA.

SMA margin is a type of account that holds excess margin generated from a client’s margin account and allows them to increase their buying power for securities.

It can be used for various purposes, such as buying more securities, withdrawing cash, transferring funds, or paying off debit balances. However, it also comes with some risks, such as market losses, margin calls, interest charges, and exchange rules. Investors should understand how SMA works and how it can affect their trading activities before using it.

How to open an SMA margin account

To open an SMA, you will need to contact a broker. The broker will ask you to provide some information, such as your income, your investment goals, and your risk tolerance. The broker will then review your application and determine if you are eligible to open an SMA margin account.

Once you have been approved for an SMA margin account, you will need to deposit funds into your account. The amount of money that you need to deposit will vary depending on the broker and the type of SMA margin account that you open.

Once you have deposited funds into your account, you can start using SMA to purchase securities. When you purchase a security using SMA, you will be borrowing money from your broker. The amount of money that you can borrow will depend on the value of the security and the margin requirement set by your broker.

You will be charged interest on the amount of money that you borrow from your broker. The interest rate charged on margin loans is typically higher than the interest rate charged on other types of loans.

You will be required to maintain a certain amount of equity in your SMA. The amount of equity that you need to maintain will depend on the margin requirement set by your broker. If the value of the securities in your account decreases, you may be required to deposit additional funds into your account to maintain your equity balance. If you are unable to deposit the required funds, your broker may liquidate some of the securities in your account.

Here are some of the steps on how to open an SMA margin account:

Choose a broker

There are many different brokers that offer SMA. Do some research to find a broker that is reputable and that offers the features and services that you are looking for.

Apply for an account

Once you have chosen a broker, you will need to apply for an SMA. The broker will ask you to provide some information, such as your income, your investment goals, and your risk tolerance.

Deposit funds

Once your application has been approved, you will need to deposit funds into your SMA margin account. The amount of money that you need to deposit will vary depending on the broker and the type of SMA that you open.

Start trading

Once you have deposited funds into your account, you can start using SMA to purchase securities. When you purchase a security using SMA, you will be borrowing money from your broker. The amount of money that you can borrow will depend on the value of the security and the margin requirement set by your broker.

Types of SMA margin accounts

There are two main types of SMA: regular SMA accounts and prime brokerage SMA margin accounts.

Regular SMA margin accounts

These accounts are available to all investors, regardless of their experience or trading level. These accounts typically have lower margin requirements than prime brokerage accounts, making them a good option for investors who are new to margin trading or who do not need a lot of margins.

Prime brokerage SMA margin accounts

These accounts are designed for experienced traders who need a lot of margins. These accounts typically have higher margin requirements than regular SMA, but they also offer more features and services, such as access to research and trading tools, and lower interest rates on margin loans.

Here is a table that summarizes the key differences between regular SMA and prime brokerage SMA:

Feature Regular SMA Margin Account Prime Brokerage SMA Margin Account
Margin requirements Lower Higher
Features and services Fewer More
Interest rates on margin loans Higher Lower
Target audience New and inexperienced traders Experienced traders

If you are considering opening an SMA, it is important to decide which type of account is right for you. If you are new to margin trading or do not need a lot of margins, a regular SMA margin account may be a good option for you. If you are an experienced trader who needs a lot of margins, a prime brokerage SMA may be a better option for you.

Compare the features and services offered by different brokers before opening an SMA Some brokers offer research and trading tools, while others offer lower interest rates on margin loans. It is important to find a broker that offers the features and services that you need.

How to use SMA margin to trade securities

To use SMA to trade securities, you will need to:

Open an SMA margin account

You can do this by contacting a broker and applying for an account. I stated how you can do that above.

Deposit funds into your SMA margin account

The amount of money that you need to deposit will vary depending on the broker and the type of SMA margin account that you open.

Place a trade

When you place a trade, you will be able to borrow money from your broker to purchase the security. The amount of money that you can borrow will depend on the value of the security and the margin requirement set by your broker.

Pay interest on the borrowed money

You will be charged interest on the amount of money that you borrow from your broker. The interest rate charged on margin loans is typically higher than the interest rate charged on other types of loans.

Maintain a certain amount of equity in your SMA margin account

The amount of equity that you need to maintain will depend on the margin requirement set by your broker. If the value of the securities in your account decreases, you may be required to deposit additional funds into your account to maintain your equity balance. If you are unable to deposit the required funds, your broker may liquidate some of the securities in your account.

SMA Margin: How to Manage Risk

SMA margin, or special memorandum account, is a type of account that holds excess margin generated from a client’s margin account and allows them to increase their buying power for securities. However, using SMA also involves some risks, such as market losses, margin calls, interest charges, and exchange rules. Therefore, investors should be careful and prudent when using the SMA margin for their trading activities. Here are some tips for managing risk when using SMA margin:

Monitor your SMA balance and your margin requirements regularly

You should check your SMA balance and your margin requirements at the end of each trading day to make sure they are positive and met. If your SMA balance is negative or zero, or if your Reg T initial requirement is not met, you cannot use your SMA for any purpose. You may have to deposit more cash or sell securities to restore your SMA balance and meet your Reg T requirement.

Avoid using your SMA to buy more securities on a margin

If you use your SMA to buy more securities on margin, you will increase your debit balance and incur more interest charges. You will also increase your exposure to market fluctuations and potential losses. You may have to pay off or reduce your debit balance with cash or securities to avoid interest charges and margin calls.

Use your SMA to pay off or reduce your debit balance

If you have a positive SMA balance and a debit balance in your margin account, you can use your SMA to pay off or reduce your debit balance. This will lower your interest charges and free up more buying power. However, you should make sure that you still meet your Reg T initial requirement after using your SMA.

Use your SMA to withdraw cash or transfer funds only when necessary

If you have a positive SMA balance and you meet your Reg T initial requirement, you can use your SMA to withdraw cash or transfer funds to other accounts. However, you should do this only when necessary, as this will reduce your buying power and may trigger margin calls if the equity falls below the minimum requirement.

Check with your broker or exchange before using your SMA for any purpose

Different brokers or exchanges may have different rules or restrictions on how SMA can be used. They may also charge fees or commissions for using SMA. You should check with your broker or exchange before using your SMA for any purpose, such as buying options or futures contracts, buying securities on foreign exchanges, or buying securities that are not marginal.

Follow the minimum standards for the use of loss data under the SMA

The Basel Committee on Banking Supervision has proposed a revised operational risk capital framework that introduces the Standardised Measurement Approach (SMA) for operational risk. The SMA uses a Business Indicator (BI) component and a Loss Component (LC) to calculate the operational risk capital requirement. The LC is based on the bank’s internal loss data and requires banks to follow certain minimum standards for the identification, collection, and treatment of loss data.1 You should follow these minimum standards if you use the SMA for operational risk.

In Conclusion, SMA margin is a type of account that holds excess margin generated from a client’s margin account and allows them to increase their buying power for securities. It can be used for various purposes, such as buying more securities, withdrawing cash, transferring funds, or paying off debit balances. However, it also comes with some risks, such as market losses, margin calls, interest charges, and exchange rules. Investors should understand how SMA works and how it can affect their trading activities before using it.

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