Understanding the Power of Open Trade Equity (OTE)
Open trade equity (OTE) represents the net unrealized gain or loss on open derivatives positions. In simpler terms, OTE signifies the potential profits or losses based on the current market value versus the price initially paid or received for a position. Once the position is closed, these values translate into realized gains or losses.
Key Takeaways
- Open Trade Equity (OTE) reflects unrealized gains or losses on open positions.
- OTE is invaluable for traders, particularly when dealing with margined accounts, as it provides real-time insight into potential profit and loss.
- Positive OTE increases the likelihood of achieving a profit, while negative OTE hints at potential losses.
Deep Dive into Open Trade Equity
OTE is crucial for margin investors as shifts in OTE can affect the available equity in their trading accounts. If unrealized losses lead to equity dropping below the maintenance margin, a margin call is issued, compelling the investor to inject additional funds or liquidate positions to meet the margin requirements.
Equation for Total Equity:
Total Equity = Account Balance ± Open Trade Equity
Since maintenance margins are legally binding contracts with brokers, investors must uphold these margins. In the event of failing a margin call from insufficient funds or unwillingness to sell holdings, brokerages have the right to close open positions to meet the minimum required account value.
Practical Example of OTE in Action
Imagine a trader starts with $10,000 and buys 50 shares of XYZ at $200 per share. The total investment is $10,000 hence, initially, OTE stands at zero. The following day, each share’s value increases to $250, leading to a $2,500 unrealized gain. Consequently, the trader’s OTE is now $2,500, elevating total equity in the account to $12,500. Crystallizing this gain into realized profit only happens once the position is closed. Until then, any fluctuations affect the OTE.
Should the stock value plummet to $100 without liquidation, an unrealized loss of $5,000 is incurred, rendering the OTE to negative $5,000, with the account equity reducing to $5,000. A negative OTE signifies potential losses unless the position rebounds or is closed early.
Navigating Margin Calls with Open Trade Equity
Per FINRA, if an investor wishes to start a margin account, they must initially deposit at least $2,000. Maintenance margin requirements kick in thereafter, enforcing a minimum account balance relative to the total market value of held securities, usually around at least 25%, though often higher.
For instance, an investor targets 500 shares priced at $20 each but lacks the needed $10,000. They open an account with $5,000, borrowing the remaining $5,000 from the broker under a 50% margin. At purchase, the OTE is zero while the total investment stands at $10,000. Should share prices drop and overall value fall to $6,000, the OTE adjusts negatively to -$4,000, making the initially $5,000 invested value worth just $3,000 and breaching the required $3,500 maintenance margin. Resultantly, a margin call is triggered.
Now the investor must deposit $2,000 or opt to liquidate certain holdings to balance and meet margin calls, often realizing losses if markets haven’t rebounded.
Related Terms: unrealized gain, margin call, maintenance margin, marked-to-market, realized profit, unrealized loss
References
- Financial Industry Regulatory Authority (FINRA). “4210. Margin Requirements”.
- Financial Industry Regulatory Authority. “Know What Triggers a Margin Call”.
