What is the Collateral Amount in Demat Account?
To buy equity shares or derivatives like futures and options in the stock market, you will need to first deposit funds into your trading and demat account. But, what if you’re slightly short of funds? In such a case, a way to fund your purchases is 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 stockbrokers 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’?
For 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 number of funds available in your trading account.
When you avail of this service, you 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 fully. Upon repayment of the margin along with the accrued interest, the collateral is released. You are then free to either sell or transfer the shares. In case you’re unable to repay the collateral amount, then the stockbroker can sell the pledged shares and recover the loan amount.
Advantages of Collateral Margin
Some of the advantages of collateral margin while trading in the stock market are listed below:
- It increases your purchasing power.
- It allows you to put idle shares in your online Demat account to good use.
- It can enhance the rate of return on your capital.
- It allows you to gain 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’, let’s take a look at some of the important things that you should know about collateral margin.
Are there any conditions to avail a collateral margin?
Yes, as an investor, you will be required to maintain a specific percentage of funds of the value of the margin into your trading account.
How is the eligible amount of collateral margin 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.
How can the collateral margin be used?
You can use the collateral margin offered by the stockbrokers to buy equity shares in the stock market. Additionally, you can also use the margin to trade in derivative contracts such as buying and selling of stock and index futures and options.
While the collateral amount offers you plenty of benefits, keep in mind that if you fail to maintain the required funds or repay your stockbroker, you can lose the shares you would have pledged. All things considered, a collateral margin can enhance your profits, provided you exercise caution and plan your trades smartly.