What is Same-Day Substitution?
How Does Same-Day Substitution Work?
Let's assume you want to buy 500 shares of Company ABC for $5 per share but don't have the $5,000 necessary to do so -- you only have $2,500. If you buy the shares on , you essentially borrow the other half of the from the brokerage firm and collateralize the with the shares. This original loan amount as a percentage of the amount is the .
If the value of the shares drops past a certain point, say 25% of the original $5 value (or $1.25 per share; this point is called the ), the brokerage firm may make a , meaning that within a few days you must more or sell some of the shares to all or part of the difference between the actual price and the maintenance margin.
However, if the value of Company XYZ falls but the value of Company ABC increases by the same amount, the same-say substitution effect means that the account balance stays the same and you avoid getting a margin call.
Why Does Same-Day Substitution Matter?
accounts allow investors to make with their ' . A is a brokerage firm's demand that a margin-account client make up the difference between a security's price and a minimum .
Margin accounts can magnify , but they can also magnify losses. Getting a margin call means that not only do you have to pay back the original $2,500 of eventually, but you have to pay the margin call. In some cases, a brokerage firm can sell an investor's securities without notification or even sue if the investor does not fulfill a margin call. However, if the rises from $5 to, say, $15, you've just made $10,000 without all of your own money. For these reasons, margin accounts are generally for more sophisticated investors who understand and can handle the risks involved.