You've identified a sure-fire, can't-miss, once-in-a-lifetime stock investment. The only issue is getting you hands on a enough money to make the bet worth your while. How to get some additional funds to buy the stock? It's called margin.
Investors can set up a margin account with a brokerage firm, which allows them to borrow up to 50% of a stock purchase price to make the transaction. From the account holder's point of view, this money just magically appears. But it has to come from somewhere. On the other side of the transaction, the brokerage usually gets this money from a bank...they are borrowing the money, just like you are borrowing it from them.
Known as call money, this is a very short-term loan that banks make to brokerage firms. The rates are not available to the general public, and are somewhat risky for the brokerage, as the bank could call in the loan at any time. If that happens, it would force the brokerage firm to come up with the money to pay it back, or force their client to pay it back early (which would probably not go over well).
So let's say Can't Lose Inc. wants to purchase 100,000 shares of a hot stock priced at $30 per share on their margin account. They promise to pay the money back within 30 days after they have bought and sold the stock. The brokerage firm Play Today Pay Tomorrow does not have that kind of cash available to loan out, so they go to a bank who gives them a call money rate of 6%.
Can't Lose buys the stock on margin at $30 a share and sells it for $35 a share 20 days later. This gives them plenty of time to pay back their margin loan and pocket the $5 a share profit. Play Today is also happy because they can pay back their call money loan to the bank within the 30 days. If Can't Lose could only sell their shares at $25 a share, they would have to make up the difference to pay back the brokerage firm.
Related or Semi-related Video
Finance: What Is a Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
Up Next
What is a put option? A put option is a type of contract that lets the investor sell shares of a stock at a certain price and within a window of ti...