Money works silently in our bank accounts, growing each year steadily at rate of 4 to 6% per annum. With fixed deposit, it works harder and it works hardest when put in good quality stocks or mutual funds. Money loves the idea of compounding and builds itself. But it cannot work if it is kept idle in a trading account. Then it would only be me who will work via trades but not my money.
To let money work on its own in a trading account, one can pledge the share / MF holdings. By pledging, I allow my broker (Zerodha) to create an extra trading limit aka collateral margin. While I can use trading limit to undertake intra-day or positional trades in F&O segment, I also allow my money to keep earning on the funds or shares that are pledged. And so, both I and my money work on the trading account.
But there is no such thing as free lunch and one must be mindful of following points..
- Collateral margin from pledging cannot be used for buying options or for buying stocks…yeah, such a bummer.
- A percentage called haircut is deducted from overall corpus being pledged i.e. if I pledge Rs. 100 of stock which has a haircut of 10%, I would be entitled to trade only with Rs. 90. Furthermore, this Rs. 90 of collateral margin will be adjusted for the price variations in the security at the end of each trading day.
- For overnight F&O positions, 50% of the margin needs to compulsorily come in cash and remaining 50% in terms of collateral margin. For example, a future / option trade requiring Rs. 1,00,000 of margin will require Rs. 50,000 as cash irrespective of collateral margin. Otherwise, account will be in debit balance attracting penalty of 0.05% per day applicable to the debit amount.
- Liquid funds are exempted from the above 50% cash:collateral rule i.e. corpus after haircut is treated as ‘cash’ anyway.
- Pledging and un-pledging follows T+1 settlement. For example, if I pledge my stock today, I would receive collateral margin tomorrow (or even on T+2 as the case may be)
- Losses on F&O using collateral margin should be adjusted with capital, else the broker has right to square off pledged holdings to make up for the losses (recent example being Archegos)
Now Zerodha allows pledging of almost all important stocks, mutual funds (yes, it does), ETFs, gold bonds and liquid funds. The latter two i.e. gold bonds and liquid funds are classified as cash components (and follow point 4 as mentioned above). Anything else being pledged is non-cash and must comply with 50-50 cash-collateral rule. This link provides complete details about securities and their haircut. It gets updated every month.
Since I am primarily an option seller, pledging can definitely help me with the extra leverage. The problem for me is that I do not have much capital. Hence, it is not prudent for me to buy mutual funds, pledge them and still maintain lot of cash for carrying option trades. Besides, I have a negative bias for market anyway this year. Therefore, I currently have liquid fund whose pledging lets me give collateral margin as ‘cash’.
The return from liquid fund (albeit very low these days) adds to any gain made from trading options. This strengthens the power of compounding. In future, I would like to maintain more cash so that I can buy Nifty ETF. That would mean an approx return of 15% via ETF + a hopeful 15% from option selling. Quite a dream but it would be really awesome to witness money working so so hard.