Last Updated on October 4, 2023 by BFSLTeam BFSLTeam
When delving into the world of equity trading or engaging in derivatives like futures and options within the stock market, one must initially deposit funds into their trading and Demat accounts. However, what if your funds fall slightly short of your investment goals? In such situations, the traditional route would involve seeking a loan from a bank or financial institution. Yet, the high-interest rates often attached to such loans can introduce an element of risk.
Alternatively, some Indian stockbrokers offer a creative solution by allowing traders to leverage the shares held in their Demat accounts. This collateral-based approach enables individuals to utilise their existing shareholdings to fund new security acquisitions. In this detailed explanation, we will explore the concept of “what is collateral amount” or “Collateral Margin,” shedding light on its significance in the trading landscape.
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What is ‘Collateral Amount’ in Demand Account?
In the context of an online Demat account, the collateral amount in demat account serves as a loan extended by a stockbroker against the shares contained within the account. It is also referred to as the collateral margin. This facility empowers traders to augment their trading limits by effectively injecting additional funds into their trading accounts.
To avail of this service, traders pledge the shares stored in their Demat accounts with their stockbrokers. Rather than disbursing cash, the stockbroker boosts the trader’s trading limit in exchange for this collateral. Typically, the broker levies a fixed interest percentage for providing this service.
During this process, the pledged securities remain locked as collateral amount in demat account, temporarily preventing their sale until the trader repays the margin borrowed from the stockbroker in full, along with any accrued interest. Once this repayment is completed, the collateral is released, and traders regain the ability to sell or transfer the shares. In cases where the trader is unable to meet the collateral repayment, the stockbroker retains the right to sell the pledged shares to recover the outstanding loan amount.
Also Read: Transfer Funds Into Your Trading Account
Benefits of Collateral Amount in Demat Account
Several advantages or benefits are associated with utilising collateral amount when trading in the stock market:
1. Increased Purchasing Power:
Collateral margin effectively bolsters your ability to make purchases in the market by expanding your trading limit.
2. Optimising Idle Holdings:
It permits traders to leverage dormant shares within their online Demat accounts, thus putting them to productive use.
3. Enhanced Return Potential:
The collateral margin can lead to an improved rate of return on your capital as it enables you to engage in more substantial trading activities.
4. Profit from Price Fluctuations:
Traders can capitalise on short-term market price fluctuations by using the collateral margin to execute timely trades.
The collateral facility essentially allows your idle shares to work for you. When you have stocks sitting in your Demat account that aren’t actively being traded, these can be pledged as collateral. This means your shares are used as security for loans or margin trading, enabling you to access funds without selling your stocks. Consequently, your dormant assets become productive, as the stockbroker uses them to facilitate your trading activities. This can be particularly beneficial when your stocks are not experiencing significant price movements or when you want to maintain long-term investments while engaging in short-term trading.
6. Maximise the Interest Rate:
The presence of a collateral amount in your Demat account can also help you maximise the interest rate you earn. As you leverage this collateral to engage in trading activities and potentially generate profits, your overall account balance increases. With a higher account balance, you stand to earn more significant returns on your investments. This, in turn, enhances the effective rate of interest on your idle funds. In essence, your money is put to more productive use, ensuring that it works harder for you and generates higher earnings than it would if left stagnant.
7. Tackle Volatility Better:
Successfully navigating market volatility requires a keen understanding of market trends and the ability to act swiftly. The collateral amount in your Demat account can significantly aid you in this regard. Since it increases your buying power, you have the flexibility to capitalise on market fluctuations. When you anticipate market volatility, you can use your collateral to seize opportunities as they arise. This might involve buying low and selling high during market swings, effectively maximising your profit margin. It’s important to note, however, that trading in volatile markets can be risky, so careful analysis and risk management are essential to making the most of this benefit.
All-in-all, having a collateral amount in your Demat account offers several advantages, including increased purchasing power, the ability to make idle shares work for you, the potential to maximise interest rates, and improved capacity to tackle market volatility. However, it’s crucial to trade cautiously, as you’ll eventually need to return the collateral amount, and market fluctuations can impact your trading outcomes.
Key Considerations about Collateral Amount in Demat Account
To fully grasp the concept of the collateral amount in demat account, it’s crucial to be aware of some essential aspects:
- Conditions for Availing Collateral Amount
Traders must maintain a specific percentage of funds relative to the margin value in their trading account to access collateral margin.
- Calculation of Eligible Collateral Amount
Stockbrokers typically do not extend the entire market value of pledged shares as collateral margin. They calculate the collateral amount by applying a predetermined “haircut amount” percentage to the present market value of the pledged shares. This haircut amount acts as a safeguard against potential reductions in the market value of the shares.
- Utilisation of Collateral Amount
The collateral amount can be employed to acquire equity shares within the stock market. Additionally, it can be used to engage in derivative contracts, such as trading stock and index futures and options.
Conclusion
While the collateral amount in demat account offers a range of benefits, it is imperative to exercise caution and prudent planning. Failure to maintain the required funds or meet obligations to your stockbroker could result in the loss of the shares pledged as collateral. In essence, the collateral margin can significantly enhance profit potential, provided traders remain vigilant and strategic in their trading endeavours.
