Some securities, especially volatile ones, will have higher margin requirements set by brokerages. When trading stocks, the initial margin will be used to partly purchase shares of a particular stock or set of securities. You’ll contribute your initial margin, and the broker will https://www.topforexnews.org/investing/is-buying-bonds-a-good-idea-when-economy-sours/ contribute a complementary amount. The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have a very high value, a trader can buy or sell the contract with a much smaller amount, which is known as the initial margin.
Investment brokers typically extend a loan to investors by opening a margin account. In other words, when you buy an asset, you and the broker will share the cost. In stock trading, the initial margin is used to increase your purchasing power, but with options, your initial margin is used as collateral to secure a position. If you find yourself coming up short, an investment broker will commonly allow you to purchase stocks or other assets on margin. This is the amount the trader must keep in the account due to changes in the price of the contract. If the market moves in the trader’s favor, this leverage enables the trader to realize significant profits on even small price changes.
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. Once the stock has been purchased, the maintenance margin represents the amount of equity the investor must maintain in the margin account. Regulation T sets the minimum amount at 25 percent, but many brokerage firms will require a higher rate.
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 https://www.day-trading.info/life-of-a-trader-the-life-of-a-pandemic-day-trader/ power will rise to $200,000. The initial margin requirement is the amount a trader must deposit to initiate a trading position. For futures contracts, the clearinghouse sets the initial margin amount. Brokers, however, may require traders to deposit additional funds beyond the initial margin requirement in order to establish and maintain the account.
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- This affords the trader a high level of leverage to greatly amplify the effect of price changes in terms of the dollar amount of gain or loss in the trader’s account.
- If you contribute your full $7,000, your total purchasing power rises to $15,000.
The initial margin is the initial amount of money a trader must place in an account to open a futures position. The amount is established by the exchange and is a percentage of the value of the futures contract. For futures contracts, exchanges set initial margin requirements that can be as little as 3% or 12% of the contract to be traded. According to Regulation T of the Federal Reserve Board, the initial margin requirement allows traders to borrow up to 50% of the purchase price of equity securities purchased on margin. The actual amount will depend upon the broker’s requirements and some brokers may require the trader to have more than 50% on deposit. In contrast, the maintenance margin is the amount of equity that must be kept in the margin account going forward.
If the price of the stock declined further, the investor would hold less than 30 percent equity. At that point, the investor would receive a margin call from the brokerage firm. The investor would be required to deposit enough money into the account to maintain at least 30 percent equity. Regulation T requirements are only a minimum, and many brokerage firms require more cash from investors upfront. Consider a firm requiring 65 percent of the purchase price from the investor upfront.
Most brokers specify a maintenance margin, which refers to the minimum equity investors must have in their margin accounts after each trade. If your asset falls below this value, your broker may issue a margin call to bring your account value above the maintenance requirement. Initial margin vs. maintenance margin reflects two different aspects of the margin buying process, though the two are mathematically connected.
This percentage indicates how much you’ll be expected to contribute to the total purchase price. The following examples illustrate how this works with real-world assets. If the value of your asset drops, the difference is taken from the initial margin to preserve the broker’s assets. If the asset drops far enough, you may be issued a margin call, which requires depositing additional cash or potentially be forced to sell some of your securities to cover the margin call.
The Difference Between Initial Margin vs. Maintenance Margin
The maintenance margin exists to protect brokerage firms from investors defaulting on their loans. Keeping a buffer between the amount of the loan and the value of the account lessens the firm’s risk. The risk for brokerage firms is higher when stock prices plummet dramatically. For example, a crude oil futures contract on the Chicago Mercantile Exchange (CME) is for 1,000 barrels of oil. A trader, however, is not required to place this amount into an account. Rather, the initial margin for a crude oil contract could be around $5,000 per contract as determined by the exchange.
That means an investor must maintain enough cash or collateral value in the account to cover 25% of the securities owned. The two both relate to the amount of cash vs. the amount you can borrow when investing. In other words, you can’t borrow more than half the price of the investment. If your broker permits margin trading, it’ll specify an initial margin requirement, which will be expressed as a percentage.
Another alternative is for the trader to sell other investments in the portfolio to raise the funds needed to bring the account back to the initial margin level. Some brokers may automatically liquidate a position once it drops below the maintenance margin level. In futures and forex trading, the margin requirements are much lower—as low as 1% to 5% of the traded contract value. The margin posted by a trader represents a good faith deposit that the trader must keep on hand with the broker. This affords the trader a high level of leverage to greatly amplify the effect of price changes in terms of the dollar amount of gain or loss in the trader’s account. When security traders buy on margin, they pay only a portion of the stock price, which is called the margin.
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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. 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 is essentially a line of credit in which interest is charged on the outstanding margin balance. For futures contracts, exchanges set initial margin requirements as low as 5% or 10% of the contract to be traded.
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J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. Thus, to purchase this many shares, you’ll have to contribute $15,000, and the broker will provide understanding interest rates inflation and bonds an additional $5,000. Diane Costagliola is a researcher, librarian, instructor, and writer who has published articles on personal finance, home buying, and foreclosure. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism.
How Do Initial Margin and Maintenance Margin Differ?
Continuing with the same example used for the initial margin, imagine the maintenance margin is 30 percent. The value of the margin account is the same as the value of the 1,000 shares. The investor’s equity will always be $3,500 less than the value of the shares since the investor must pay back that money. The initial margin for stocks at U.S. brokerages must be at least 50 percent, according to Regulation T.