What is an Open Trade Equity (OTE)?
Open Trade Equity (OTE) is the net amount of unrealized gain or loss on open contractual positions.
Understanding open trade equity (OTE)
Open Trade Equity (OTE) measures the difference between the initial trading price of all open positions and the last negotiated price of each of these positions. The term derives from the fact that the established positions have not yet been cleared. It is useful for providing the trader with an accurate snapshot of the actual value of an account, as all open positions are valued at market prices. In other words, how much equity (money) is in the account if all positions have been closed at prevailing market rates.
Total credit = Account balance ± Open commercial credit
For example, if Alice has $ 10,000 on her account and uses it to buy 50 shares of XYZ at $ 200 per share. Its total investment is $ 10,000 and its OTE at the instance of the operation in progress is zero. The next day, the value of each share increases to $ 250. Now Alice has an unrealized gain of $ 2,500 in this trade, which means that the OTE for this participation has also increased by $ 2,500 and that the total account equity can reach $ 12,500. If it were to liquidate this item, the gains would have been realized, the account balance would have increased from $ 2,500 to $ 12,500 and the BTE would be zero. A positive OTE increases the chances of making a profit given the unrealized gains from the open position.
If she does not liquidate the position and the price drops to $ 100, Alice now has an unrealized loss of $ 5,000 on this stake. Unless Alice sells or closes this open position, this loss remains unrealized, but her OTE is ($ 5,000) and the total equity in the account has dropped to $ 5,000. A negative OTE increases the chances of realizing a loss taking into account the unrealized losses of the open position.
OTE is particularly important for margin investors because the fluctuations have an impact on the equity available on their account. If the unrealized losses cause the available capital to fall below their contractual maintenance margin, a margin call is issued when the investor is forced to deposit additional funds to bring the available capital above the contractual maintenance or to liquidate all or part of their opening positions.
Because maintenance margins are contracted with a broker, investors are legally required to maintain their margins. In the event that an investor cannot or does not want to deposit money or sell assets at the time of a margin call, his brokerage is empowered to close open positions in his client’s portfolio at his discretion in order to restore the account to its minimum value.
Key points to remember
- Open Trade Equity (OTE) is the net amount of unrealized gain or loss on open contractual positions.
- OTE is useful for providing the merchant with an accurate snapshot of the actual value of an account.
- A positive OTE improves the chances of making a profit while a negative OTE increases the chances of making a loss.
Example of open trade equity (OTE) at the margin call
The Financial Industry Regulatory Authority (FINRA) requires that any investor wishing to open a margin account must start with at least $ 2,000 in cash or securities. FINRA requires the investor to accept a holding margin of at least 25%, which means that the investor must maintain an account balance of at least 25% of the total market value of the securities held in the account at any time. Typically, this maintenance margin is contracted at a higher percentage, and it is common for maintenance margins to be 30% or more.
For example, an investor wants to buy 500 shares from a stock market at $ 20 / share. He doesn’t have the $ 10,000 needed to do so, so he opens a $ 5,000 account with a broker who has an initial margin of 50% and a maintenance margin requirement of 35%. The investor buys $ 10,000 of shares, which means that he borrowed $ 5,000 from the broker. At the time of execution, the OTE is zero, the total value of the investment is $ 10,000, the initial margin is $ 5,000 (50% * $ 10,000) and the maintenance margin is 3 $ 500 (35% * $ 10,000).
The price starts to drop where the total value of 500 shares drops to $ 6,000, which means that the OTE is ($ 4,000). The $ 5,000 that the investor put aside is now worth $ 3,000 ($ 5,000 – 50% * $ 4,000). This is less than the maintenance margin requirement of $ 3,500, so the investor receives a margin call.
At this point, the investor will need to make a deposit into the margin account to meet the 50% requirement, in this case, $ 2,000. This can take the form of a cash deposit or marketable securities. They can also choose to incur a loss on the investment by liquidating all or part of their open positions, thereby reducing their margin requirements. This usually results in the loss of their business.