What Is Initial Margin?
Initial margin is the percentage of the purchase price of a security that must be covered by cash or collateral when using a margin account. The current initial margin requirement set by the Federal Reserve Board’s Regulation T is 50%. However, this regulation is only a minimum requirement; some equity brokerage firms may set their initial margin requirement higher.
Key Takeaways
- Initial margin is the percent of a purchase price that must be paid with cash when using a margin account.
- Fed regulations currently require that the initial margin is set at a minimum of 50% of a security's purchase price. But brokerages and exchanges can set initial margin requirements higher than the Fed minimum.
- Initial margin requirements are different from maintenance margin requirements, which is the percent of equity that must be retained on an ongoing basis in the account.
How Does Initial Margin Work?
To open a margin account at a brokerage firm, an account holder first needs to post a certain amount of cash, securities or other collateral, known as the initial margin requirement. A margin account encourages investors, traders, and other market participants to use leverage to purchase securities with a total value that's greater than the available cash balance in the account. A margin account is essentially a line of credit in which interest is charged on the outstanding margin balance.
Securities in the margin account are paid for with cash loaned to the account holder by the brokerage firm and are designated as collateral. This process allows for magnification of potential profits but also magnifies potential losses. In the extreme event that securities purchased in a margin account decline to zero value, the account holder needs to deposit the full initial value of the securities in cash or other liquid collateral to cover the loss.
Futures and initial margin
For futures contracts, exchanges set initial margin requirements as low as 5% or 10% of the contract to be traded. For example, if a crude oil futures contract is quoted at $100,000, a futures account holder can enter a long position by posting only $5,000 initial margin, or 5% of the contract value. In other words, this initial margin requirement would give the account holder a 20x leverage factor.
During periods of high market volatility, futures exchanges may increase initial margin requirements to any level they deem appropriate, matching the power of equity brokerage firms to increase initial margin levels above those required by Fed regulation.
Initial Margin vs. Maintenance Margin
Initial margin is distinct from maintenance margin. The two both relate to the amount of cash vs. the amount you can borrow when investing. However, the initial margin requirement is the amount of cash or collateral required to actually purchase securities; theFederal Reserve's Regulation T sets that sum at a minimum of at least 50% of the purchase. In other words, you can't borrow more than half the price of the investment.
In contrast, the maintenance margin is the amount of equity that must be kept in the margin account going forward. The minimum maintenance margin requirement set by Reg T is 25%. That means an investor must maintain enough cash or collateral value in the account to cover 25% of the securities owned.
Maintenance margin helps ensure account holders maintain collateral in the account should the value of their securities fall. Some securities, especially volatile ones, will have higher margin requirements set by brokerages.
Example of Initial Margin
As an example, assume an account holder wants to purchase 1,000 shares of Meta, Inc. (META), formerly Facebook, which is quoted at $200 per share. The total cost for this transaction in a cash balance account would be $200,000. However, if the account holder opens a margin account and deposits the 50% initial margin requirement, or $100,000, the total purchasing power will rise to $200,000. In this case, the margin account has access to two-to-one leverage.
FAQs
For example, if a crude oil futures contract is quoted at $100,000, a futures account holder can enter a long position by posting only $5,000 initial margin, or 5% of the contract value. In other words, this initial margin requirement would give the account holder a 20x leverage factor.
What is the minimum initial margin requirement? ›
The Federal Reserve Board's Regulation T sets the minimum initial margin at 50%, meaning investors trading on a margin account must have cash or collateral to cover at least half of the market value of the securities they buy on margin.
How do you calculate initial margin requirement? ›
The total Initial margin requirement or credit for the product group is calculated by summing algebraically the total of the product group spread margin, the product group MTM margin, the product group premium margin and the total additional margin (or minimum margin) for the product group.
What does 25% margin requirement mean? ›
Key Takeaways. Maintenance margin is the minimum amount of equity that an investor must maintain in the margin account after the purchase has been made. Maintenance margin is currently set at 25% of the total value of the securities in a margin account as per FINRA requirements.
What is an initial margin of 40%? ›
An initial margin of 40% would have a purchasing power multiplier of 2.5x (1 / 40%). Therefore, an investor that contributes $100,000 in cash would have a total purchasing power of $250,000 ($100,000 x 2.5) – $100,000 in the investor's cash and $150,000 in borrowed funds; and.
What is a 1% margin requirement? ›
As another example, a 1% margin requirement is referred to as a 100:1 leverage, and allows $10,000 to be traded in the market with a $100 security deposit. In the foreign exchange market, traders tend to trade with leverages of 50:1, 100:1, or 200:1, depending on broker and regulations.
What does 60% initial margin mean? ›
A margin account allows an investor to purchase stocks with a percentage of the price covered by a loan from the brokerage firm. The initial margin represents the percentage of the purchase price that must be covered by the investor's own money and is usually at least 50% of the needed funds for U.S. stocks.
What does 30% margin requirement mean? ›
This is important to understand, because brokerage firms require that margin traders maintain a certain percentage of equity in the account as collateral against the purchased securities—typically 30% to 35%, depending on the securities and the brokerage firm.
What is the difference between initial margin and minimum margin? ›
The initial margin is the amount a trader must deposit with their broker to initiate a trading position. The maintenance margin is the amount of money a trader must have on deposit in their account to continue holding their position, which is typically 50% to 75% of the initial margin.
Why is initial margin required? ›
Initial margin is held to cover the losses that could arise in the period between the defaulter's last variation margin payment and the point at which the surviving party is able to hedge or replace the trade.
Example of Variation Margin
Let's say a trader buys 100 shares of stock ABC for $10 each. The initial margin set by the broker for purchase is 50%. This means that the broker must have $500 in his account at all times to make trades.
What does margin 5% mean? ›
Markets with higher volatility or larger positions may require a bigger deposit. Margin requirements reflect your leverage. For example, if the margin requirement is 5%, the leverage is 20:1, and if the margin requirement is 10%, the leverage is 10:1.
What is an example of initial margin and variation margin? ›
Basics of Variation Margin
For example, if a trader buys one futures contract, the initial margin on that contract may be $3,000. This is the amount of capital they need to have in their account to take the trade. The maintenance margin may be $2,500.
What is an example of initial and maintenance margin? ›
If the initial margin requirement for trading one gold futures contract is $1,000 and the maintenance margin requirement is $750, then if the balance in the trader's account drops to $725, the trader must deposit an additional $275 to bring the account back to the initial margin level.
What can be collected as initial margin? ›
Initial margin (IM) is collateral collected and/or posted to reduce future exposure to a given counterparty as a result of non-cleared derivative activity. Whilst there is a recognised process within exchange traded and cleared derivatives, this is largely a new process for non-centrally cleared OTC derivatives.
What is an example of a margin level? ›
Margin Level is the ratio between Equity and Used Margin. It is expressed as a percentage (%). For example, if your Equity is $5,000 and the Used Margin is $1,000, the Margin Level is 500%.
