- Investors borrowed a record $722.1B against their investment portfolios through November, according to the Financial Industry Regulatory Authority, exceeding the previous high of $668.9B from May 2018.
- The milestone is worrying for the stock market because margin debt highs tend to precede periods of volatility as experienced in 2000 and 2008.
- Investors using margin debt pledge their securities as collateral for loans from brokerage firms so they can make more investments. But if the value of their collateral falls below a certain level, they need to either put up more money or sell the securities underlying the loan.
- Many investors are using their margin balances to trade options, contracts that gives them the right to either buy or sell shares at a pre-determined price later, the Wall Street Journal reports. Options trading surged this year as individual investors flooded into the stock market. An average of 29M traded this year, up 48% vs. 2019, according to Options Clearing Corp.
- Options can be used to hedge portfolios from stock declines or to make bigger bets that indexes or individual companies will rise or fall. But with some of the riskier strategies, investors can lose more than they pay for the contracts.
- Some investors, though, use leveraged ETFs instead of margin debt. Such ETFs lead to bigger gains when the underlying security rises but they also decline more when the security falls. They, however, don't risk a margin call or paying interest.
- Sector stocks to watch: Exchanges generally benefit when market volatility increases, so keep an eye on Intercontinental Exchange (NYSE:ICE), Nasdaq (NASDAQ:NDAQ), Cboe Global Markets (NYSE:CBOE), CME Group (NASDAQ:CME).
- Watch monthly activity reports at brokerage firms for increases in margin debt: Charles Schwab (NYSE:SCHW), Interactive Brokers (NASDAQ:IBKR), Morgan Stanley (NYSE:MS), and Raymond James Financial (NYSE:RJF).
- SA contributor Lance Roberts explains margin debt and its relation with market exuberance.