Understand the Concept of Buy Now Pay Later or BNPL

Meet Raj, Raj is a young investor with Rs. 50,000 in his trading account. He’s interested in buying shares of ABC Ltd., a well-known Indian company whose stock currently trades at Rs. 100 per share. Raj wishes he could invest more to potentially earn higher returns.

This is where trading with margins comes into play.

What is Margin Funding (MTF)?

Margin trading facility allows you to use your own money as upfront payment (margin) while borrowing extra funds from your broker to buy more stocks. In simple terms, with a margin facility, you can increase your buying power, buy now and pay the rest later.

For example, if you have Rs. 50,000 and use 4X leverage, you can invest up to Rs. 2,00,000 in stocks. The stocks you purchase serve as collateral (via an auto-pledge process) for the borrowed money.

How Does Margin Trading Facility (MTF) Work?

1. Using Your Money as Collateral:
   You pay 1/4th the amount (e.g., Rs. 50,000) upfront- this is known as the margin requirement. This deposit secures the loan you take from the broker.
2. Borrowing Additional Funds:
   With 4X leverage, your buying power increases to Rs. 2,00,000. This means you borrow Rs. 1,50,000 in addition to your Rs. 50,000.
3. Buy Now, Pay Later:
   Use the combined funds to buy stocks. For instance, if ABC Ltd. is trading at Rs. 100 per share, you can purchase 2,000 shares instead of only 500 shares you could have bought with your own money.
4. Interest and Repayment:
   The borrowed amount accrues interest for as long as your margin position remains open (With ICICI Direct you can hold your position for up to 360 days). When you sell the stocks, you repay the borrowed funds along with the accumulated interest.

Example of How Buy Now, Pay Later Works

Let’s say Raj uses his Rs. 25,000 as collateral to obtain a total buying power of Rs. 1,00,000 (using 4X leverage) and buys 1,000 shares of ABC Ltd. at Rs. 100 per share.

If price ABC Ltd. stock rises to ₹110 per share then:

While margin funding can boost your potential returns, it comes with significant risks.

Risks of Margin Trading Facility

Margin borrowing is only for experienced investors with high risk tolerance—you may lose more than your initial investment.

Using the same example above where Raj buys 1,000 shares of ABC at Rs 100 per share with his margin funds; let’s see what happens if the price drops to Rs. 90 per share:

○ Additionally, Raj still owes interest on the borrowed Rs. 1,50,000 at 9.69% per annum.

○ If the loss is severe enough to trigger a margin shortfall, Raj might receive a margin call. Failure to deposit additional funds could lead to an automatic square off of his stocks.

So, before trading with margins, understand the following risks:

• Amplified Losses:
  Trading losses can exceed your initial investment because you’re using borrowed money.
• Leveraged Investments:
  Using leverage increases the potential for higher losses if the market moves against you.
• Additional Costs:
  Interest on the borrowed funds adds extra costs that can reduce profits or increase losses.
• Margin Shortfall & Margin Calls:
  A drop in the value of your collateral may result in a margin shortfall. This can trigger a margin call, requiring you to deposit extra funds or face an automatic square off of your securities.
• Market Volatility:
  Sudden changes in the market can quickly turn a winning position into a losing one.
• Initial Margin:
  This is the minimum amount of your own money you need to contribute as a security deposit when you open a margin position. This margin requirement can vary from stock to stock and brokers.

Key MTF Terms to Know

• Pledged Shares (MTF)
  Pledged shares are stocks held as collateral for margin trading. These shares remain in the investor’s demat account but are marked as pledged to secure the borrowed margin.

• Auto-Pledging Mechanism (MTF)
  With auto-pledging, MTF shares are automatically pledged at the time of purchase, eliminating the need for manual confirmation via links or OTPs. This ensures a seamless and efficient margin funding process.

• Margin Shortfall:
  This happens when the value of your stocks (pledged shares) falls below the minimum required level. Essentially, it means your account doesn’t have enough “buffer” to support the borrowed funds.

• Maintenance Margin:
  This is the minimum margin level you must maintain in your account. Falling below this level can trigger a margin call.

• Margin Call:
  If a margin shortfall occurs, your broker will ask you to deposit extra funds or sell some stocks to restore the required balance. So, if the broker requires a 25% margin and the price of the share falls below the purchase amount the trader needs to add additional funds to make up for the margin shortfall.

• Automatic Square Off:
  If you do not meet a margin call in time, your broker may automatically sell some or all of your stocks to recover the borrowed money. This process is called automatic square off.

Charges applicable while using MTF on ICICI Direct

When you create positions in MTF, interest is charged on the funded amount. Where cash is used margin, the interest is charged on the borrowed amount and where shares are used as margin (SAM limit generated), the interest is charged on the entire funded amount. This interest depends on your brokerage plan as follows:

Conclusion

Margin Trading Facility gives you the option to invest with greater buying power by borrowing funds from your broker. While it can significantly boost profits when the market moves in your favour, it also increases the risk of larger losses—especially if the market turns against you.

By understanding key concepts like margin shortfall, margin calls, and automatic square off, as well as the added risks of leveraged investments, interest costs, and market volatility, you can make more informed decisions about whether margin trading is right for you.

Always consider the risks carefully and ensure you are comfortable with them before diving into margin trading.