Know About Collateral Amount in Demat Account

What is a Certificate of Deposit?

In order to buy equity shares or derivatives like futures and options in the stock market, you need to first deposit funds into your trading and demat account. But what if you’re slightly short on funds that can be used for trading? In such a scenario, one way to fund your equity share purchases would be to opt for a traditional loan from a bank or a financial institution. However, the high interest rates associated with a loan can make it a risky proposition.

Alternatively, some stock brokers in India offer you the option to avail a margin using the shares held in your demat account. So, if you already hold equity shares in your online demat account, you could make use of these shares to buy securities in the stock market. Read on to find out more about this service and how it can impact your trading activity.

What is 'Collateral Amount?'

With respect to an online demat account, the collateral amount is essentially a loan offered by a stockbroker against the shares held in your demat account. The collateral amount is also referred to as the collateral margin. It can help you increase your trading limit by increasing the amount of funds available in your trading account.

When you avail this service, you basically pledge the shares held in your demat account with your stockbroker. The stockbroker, in turn, provides you with a loan by enhancing your trading limit instead of disbursing cash. In exchange for providing this service, the broker usually charges a fixed percentage of interest.

When you pledge the securities available in your demat account, they are held as collateral and are temporarily blocked. This prevents you from selling the securities till the margin availed by you is repaid to your stockbroker in full. Upon repayment of the margin along with the accrued interest, the collateral held is released. You are then free to either sell or transfer the shares as per your needs. In case you’re unable to repay the collateral amount, the stockbroker is free to sell the pledged shares and recover the loan amount.

Advantages of Collateral Margin

Trading in the stock market with a collateral margin comes with several advantages. Some of these upsides are listed below.

  • A collateral margin increases your purchasing power.
  • It allows you to put idle shares in your online demat account to good use.
  • A collateral margin can enhance the rate of return on your capital.
  • It allows you to profit from short-term price fluctuations in the market.

Things you should know about Collateral Margin

Now that you’ve explored the concept of ‘collateral amount’ in your online demat account, let’s take a look at some of the important things that you should know about a collateral margin.

Are there any conditions to be satisfied in order to avail a collateral margin?

Yes. As an investor, you are required to satisfy a specific condition in order to be able to avail a collateral margin from your stockbroker. Most stockbrokers offering this facility require you to maintain a specific percentage of the value of the margin in cash in your trading account.

How is the amount of collateral margin that you are eligible to avail calculated?

Stockbrokers generally do not extend the full market value of the shares being pledged as collateral margin. The collateral margin extended is calculated by reducing a ‘haircut amount’ from the present market value of the shares you’re pledging. This ‘haircut amount’ is calculated as a percentage and is used to cover the stockbroker’s risk exposure in case the market value of pledged shares reduces.

What can the collateral margin be used for?

You can use the collateral margin facility offered by stockbrokers to buy equity shares in the stock market. In addition to that, you can also use the margin to trade in derivative contracts such as buying and selling of stock and index futures and options.

Conclusion

While the collateral amount offers you plenty of benefits, keep in mind that if you fail to maintain the required cash balance or repay your stockbroker, you can lose the shares you pledged. All things considered, a collateral margin can enhance your profits, provided you exercise caution and plan your trades smartly, so you can repay the amount promptly.

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