Cross margining is a way to take the margin, or cost, of one financial vehicle and place part of it in another account with a low margin. This can normally only be done in similar markets, such as between stocks, but some brokers may allow investors to do this between two different markets. To effectively participate in cross margining, there must be another account that has a very low margin and can accept the other margin without any problem. Primarily this is done to reduce the overall risk of trading and paying margins. When investors pay the remaining margin to brokers, if they default on the payment, then the brokers are legally able to sell the investment vehicle and collect the money from the sale.
The majority of cross margining deals can only be done among similar markets, such as with futures. Some brokers may be willing to accept the responsibility of this between two different markets, such as between futures and stocks, but this is uncommon. Cross margining between two markets is usually harder, may require more paperwork and may not decrease the risk as much as crossing over with a similar market.
Just because an investor has two investment vehicles or accounts does not mean he or she can participate in cross margining. One of the accounts must have a low margin — below the maintenance value — or this cannot be done. The account that has the higher margin does not need to have a very high margin to cross, but this is common.
The overall margin is typically lower after cross margining, so this reduces risk and makes payments easier. For example, if one derivative has been paid off, then some money can be placed on the derivative without any penalty. The derivative has already been paid off, so there is usually some room for placing the money and the investor will not have to pay extra.
There can be a major problem with cross margining if the investor does not keep up on payments. The broker is not being paid the full amount for the investment vehicle with the larger margin, so he or she has some ownership over it. This usually does not come into play but, if the investor cannot pay the broker’s fine for that vehicle, then the broker can sell it to recoup losses. If the broker sells the investment vehicle and the investor was paying on time, this is illegal and the broker can be fined.