Through this facility, investors can put up a small upfront amount called an ‘initial margin’ and take exposure worth multiples of that amount. For instance, let’s say you have ₹25,000 as cash with your broker and want to buy shares of a particular company, say, Maruti Suzuki India Ltd. In a normal delivery trade, you can exchange your cash for a proportionate amount of Maruti’s shares. But using MTF, investors can increase their bet size with just a fraction of the amount.
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Here’s how it works. Let’s assume the Maruti stock has a leverage of 4x. What this means is that if you deposit ₹25,000 (as the margin amount), the broker will lend you another ₹75,000. That way, your total exposure becomes ₹1 lakh.
To be sure, different stocks have different margin requirements specified by the stock exchanges. Investors have to put in the specified margin amount based on the stock they want to buy. However, brokers are allowed to charge more than what the exchanges specify as the margin. This margin requirement is a function of the liquidity and volatility of the underlying stock.
In the above example, the assumption was that the investor paid this margin with cash. Investors can also dabble in such trades without cash—They can deposit their existing shares with a trader as margin to take leverage.
But for this, they need to keep in mind the haircut of the underlying holdings. Let’s say you have ₹50,000 worth of shares of a particular company, Tata Power, for instance, in your demat account and want to use that as a margin. Remember that you had to pay an upfront amount of ₹25,000 if the margin was in cash but shares come the risk of price volatility. What if the share price falls? To safeguard themselves from such volatility, brokers need to take a higher margin.
This extra cushion required for keeping shares as margin is called the haircut. Consider that the Tata Power shares have a 25% haircut. This simply means that you can use only 75% of what your holdings of Tata Power are worth currently. In this case, to get the equivalent of ₹25,000 cash margin, you have to deposit ₹33,333 worth of Tata Power shares. This haircut percentage varies from one ticker to another.
To be sure, all brokers provide margin trading facility for intraday trades but if one wants to take leverage on a weekly or monthly price trend, they have to do it using MTF. Not all brokers, though, have the MTF facility.
A similar leverage position can also be taken through a futures contract and that requires a lesser margin than with MTF. But for futures, traders have to buy in lots and that requires a higher minimum ticket size. Futures also have a certain expiry date, whereas stocks under MTF could be held for a longer duration. Also, the number of stocks in the futures segment is limited whereas MTF has a much wider universe. Future contract gains are taxed as business income and thus attract a higher tax rate. MTF trade gains are usually taxed at a lower 15% as short-term capital gains.
“For an investor who wishes to have a long-term view and wants to use leverage, MTF has few advantages over futures. The minimum quantity of shares which an investor can choose to buy under MTF can be as low as one, unlike a futures contract where minimum lot size and quantity are predefined. Also, there is no need to roll over contracts every month where the spread between two contracts impacts average cost in futures trade” said Jay Prakash Gupta, founder of Dhan, which allows MTF in more than 950 scripts.
What’s the payoff?
While promoting MTF, most brokers tend to focus more on maximizing returns with borrowed money. This is a tricky affair since a wrong bet can wipe out the entire or huge chunk of capital in a short span. Let’s try to understand this using the earlier example.
Suppose you’ve bought Maruti shares worth ₹1 lakh with a margin of ₹25,000. After a few days, if the stock price goes up 10% and you sell it off, the investment is worth ₹1.1 lakh. You have made a profit of ₹10,000 by investing just ₹25,000. That’s a neat 40% return in a matter of a few days.
However, instead of those Maruti shares going up, let’s assume it falls 10% due to various factors. In this case, you lose ₹10,000 straight away (a 40% loss). The ₹25,000 margin amount would be reduced to ₹15,000. The broker will also inform you to put in an extra amount to fill in this gap. If the stock price goes down further, the broker can issue a margin call and close your position. The price at which your holdings are squared off varies from one broker to another.
A risk management executive from a broking house told Mint that his firm sends email notifications if the initial margin dips. If the holding value goes below what the broker had lent, the firm is at risk of losing money. For this reason, once the holding value goes below 115% of what the firm had contributed, it would immediately square off the position. To avoid such a situation, investors need to maintain sufficient balance in their accounts.
Nirav Karkera, head of research at Fisdom, says MTF is a strong value proposition for investors who understand the trade’s nuances and intricacies but those with limited understanding tend to make losses. “Think of it as a double-edged sword offering the ability to win if wielded correctly, but also runs the risk of cutting oneself. Like with most innovations, the classification of a weapon or tool depends on its use and application.”
What are the charges?
Brokers benefit from MTF in three ways. First, they charge an interest for the amount that they have lent . Typically, brokers charge somewhere between 9% and 20% per year and this interest amount is collected daily. If a broker is charging 8%, an investor would have to shell out ₹16 every day as interest cost to the broker, assuming the loan is ₹75,000. This amount gets deducted from the investor’s account. The interest charged by a broker is a function of the cost of raising funds.
Second, most brokers charge a brokerage fee on all MTF trades. Besides, some brokers charge an additional subscription amount for providing this facility.