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How to Hypothecate Common Stock


Hypothecation is a legal term meaning to pledge something of value as collateral. In the financial markets, to hypothecate common stock means to pledge it when a broker loans you money for stock transactions. In simple terms, you hypothecate common stock when you open a margin account with a broker. Margin accounts are required not only for buying stocks on margin, but for any trade that may involve borrowing funds, including short sales, stock futures and options.


Instructions

Apply with a brokerage firm to open a margin account. Because you will have borrowing privileges, this is like opening other credit accounts. You'll need a good credit score and a statement of your net worth and income. Under federal regulations, if you work for a firm that handles securities, you must also have your employer's written permission.


Read the hypothecation agreement carefully before you sign it. Under federal law and New York Stock Exchange rules, your broker must require that you put up a minimum amount (called the margin requirement) anytime you borrow money for a transaction and keep a minimum equity (called the maintenance requirement) while holding any margined security. However, brokers are free to impose stricter standards, so don't assume the hypothecation agreement requires only the legal minimums. Sign the hypothecation agreement once you understand the terms.


Deposit the required cash minimum to complete opening your margin account. Typically initial deposits must be two to three times as large as those required for regular cash brokerage accounts, and as much as 10 times more than that for day trading accounts. For example, if the minimum for a cash account is $1000, expect a margin account minimum to be around $2500, and $25,000 for day trading.


Understand your obligations when you hypothecate common stock. You are agreeing that any common stock or other cash and securities in the account are collateral for the money you borrow. If the market goes against you, you will get a margin call from your broker. At that point you must add enough cash to the account to bring it up to margin requirements or your broker is required to sell any securities in the account needed to recover the money you have borrowed.
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The broker will charge interest on funds you borrow and these must be factored in when estimating the advisability of a particular stock transaction. Bear in mind that margin transactions exist to allow you to leverage stock trades, increasing your risk as well as possible profit.