I request seniors to help me understand one concept that I never really understood. It is stupid but can anyone of you rationally answer it with honesty please because High Leverage is a major reason for a loss.
How does Brokers in our country manage to give x14, x16 and some to even x20, x40 leverage on MIS Equity trades? Some are even giving x8, x10 for risky MIS Option Writings.
This means somebody with 5L cap can easily go upto 50L for a position
I am interested to know what happens on the Brokers side? Because mere 100 such Day Traders could easily knock 50Crs. That’s a lot of money, does our Brokers really keep that much up of cash or is it the cumulative floating margin of all clients that facilitate this huge Margin requirements on Daily basis. What happens when there is a shortfall from Broker’s end?
Net net how come Brokers manage such high leverage Trades?
The answer is there in the Question, These are intraday products, when the books are totaled out in the evening, these leverage does not exist in the system.
More turnover means more brokerage charged to clients and more cutbacks received by the broker from the exchanges. Exchanges pay commission based on slabs to brokers for the business they bring in, More business higher commissions.
No, Leveraged trades are continuously monitored by the high efficient Algorithms at the Brokers Office. These computers close your trades as soon as your loss nears 50 - 80% of your deposited funds.
For overnight products you bring in margin as required by the exchange and not as required by the broker.
In rare cases, shortfall can happen, most brokers write it off to maintain goodwill, some brokers will recover their losses from your assets by sending the Mafia to your door.
Firstly intraday leverage is offered by discount, full service (all kinds of brokers).
When you buy/short stocks, exchange doesn’t ask for 100% of funds or stocks instantly. They block a VAR margin (approximately 6.5% and upwards, increases with volatility of the stock) - on both Buy/Sell trades. The settlement happens on T+1 and T+2 day. So if a broker is allowing leverage for intraday, he isn’t really doing with his own capital (to the extent of intraday leverage provided). So if it is 8% for Reliance, then upto 12 times leverage broker can provide without his own capital. Post 12 times, any further leverage provided, margin gets blocked from brokers funds.
With regards to F&O - most contracts are already leverage 4 to 8 times (higher in currency/commodity). That is the nature of derivative contracts. If a broker is offering leverage intraday, it would be getting blocked from his capital (btw, with all the new regulations coming in, I don’t think brokers will be allowed to offer intraday leverage in F&O soon). I am guessing u telling x8, x10 is basis brokers who block between 25% to 50% of overnight margin requirement for option writing for intraday trades.
Why do brokers do it?
Traditionally brokers have earned a % brokerage. So higher the value of the trade, the more the fees generated. So it is a no-brainer on why traditional brokers offered leverage.
When we started flat fee pricing model where there is no incentive in offering leverage, we were kind of forced to offer some leverage as it was the industry norm. We have never competed with others on high leverage.
Why not compete?
Leverage is like WMD (weapons of mass destruction), most people don’t know how to handle it. Higher the leverage offered, more people burn out trying to use it (there is enough data to prove this) If we had an option, we would keep it as low as possible. Unfortunately to stay competitive we are required to offer.
Yep, that is the nature of this business (similar to insurance companies) - risk management is the key. The day shit hits the roof (happens once or twice every decade), some brokers are going to go bankrupt. There will be no way to manage risk on such days, and clients are bound to lose more than what they have and cause damage to the brokers.
What can you do (as a client and what we do as Zerodha)?
If you think we are closer to an event, the last happened in 2008 - trade with well capitalized broker. We at Zerodha have over 400 crores of our own money in the business.
Trade with brokers who aren’t extremely aggressive on leverage. There are many brokers who offer any kind of leverage if you guarantee brokerage revenue. At Zerodha we have one deal for all our customers (conservative when compared to competition). Because of this, the extremely large and aggressive traders don’t use our platform (these are the ones who bring systemic risk on days things go bad).
Trade with brokers who are strict when it comes to risk management. The only way for a brokerage to run in long term taking so many clients risk is by being extremely strict and sticking to the margin policies set. At Zerodha all risk management is rule based (automated). We cut out all leverages on days when we expect volatility - knowing very well that some of our clients who don’t appreciate why we are doing it can move out to competition.
One thing I realize while reading NIthin’s answer is that he has a smart business mind! He doesn’t seem to follow the traditional business practices of other brokers to bring revenue by increasing trade volumes. Rather he is doing innovative value additions thru technology to bring extra business (look at the many supporting apps he has started under zerodha universe which all are chargeable). @nithin : we atleast deserve a FREE option chain (with live greeks) in zerodha kite. You are charging us even for that thru an associated app??
I can now somewhat practically relate to a Chapter read in Varsity related to VaR. But lot of knowledge remains to be acquired for this least discussed complex subject of Margin and Leverage.
Yes. But I still fathom (particularly) in this case by whom and how the remaining Required Margin is satisfied? By default, Option Buying already leverages x100 compared to Buying Stocks. Leverage on top of that are even given. One needs to be damn sure about the direction while using such unprecedented leverage.