What does the initial margin mean?
The initial margin is the amount of money you need to put down as collateral or cash to cover the purchase price of a property when you use a margin account. Regulation T from the Federal Reserve Board says the starting margin requirement is 50%. This rule is only a minimum; some stock brokerage firms may increase their initial margin demand.1
How does the first margin work?
A person who wants to start a margin account at a brokerage firm must first put up a certain amount of cash, securities, or other collateral. This amount is called the initial margin requirement. Investors, traders, and other market players can use leverage to buy securities whose total value is higher than the amount of cash in the account when they have a margin account. A margin account is a line of credit where interest is added to the amount of money still owed on the margin.
Stocks in a margin account are bought with cash that the brokerage company lends to the account holder and sets up as collateral. This process makes it possible to make more money but also makes it easier to lose more. In the worst case, the value of securities bought on margin drops to zero. To cover the loss, the account holder must deposit the total original value of the securities in cash or another liquid asset.
Futures and the first gap
When you first buy a futures contract, the exchange may only need as little as 5% or 10% of the deal value. For instance, if the price of a crude oil futures contract is $100,000, the smallest amount of money needed to open a long trade is $5,000, which is 5% of the value of the contract. For example, this starting margin requirement would give the account holder 20 times the amount they could borrow.
During times of high market volatility, futures exchanges can raise initial margin requirements to any level they think is right. This is similar to how trading firms can raise initial margin levels above what the Fed requires.
Beginning Margin vs. Continuing Margin
The maintenance margin is not the same as the initial margin. Both have to do with how much cash you have vs. how much you can borrow to spend. On the other hand, the starting margin requirement is the amount of cash or collateral needed to buy securities. According to Federal Reserve Regulation T, this amount must be at least 50% of the purchase price. You can’t borrow more than half of the investment’s cost.
On the other hand, the maintenance margin is the amount of equity that needs to be kept in the margin account in the future. Reg T says the minimum upkeep margin that must be used is 25%. That means an investor must always keep 25% of their stocks in cash or collateral in their account.2
Maintenance margin helps account users keep collateral in their accounts in case the value of their securities goes down. Brokerages will set higher margin requirements for some assets, especially ones likely to go up and down in value.
An Example of the First Margin
For example, someone with an account wants to buy 1,000 shares of Meta, Inc. (META), which used to be Facebook and currently trades at $200 each. In an account with a cash sum, this deal would cost $200,000. The person with the account can buy more things if they open a margin account and put in the $100,000 required as an initial margin payment. The margin account can use two-to-one leverage in this case.
Conclusion
- When you use a margin account, the initial margin is the amount of the price of an item that you have to pay in cash.
- Fed rules say that the original margin must be at least 50% of the security price being bought. Brokerages and exchanges, on the other hand, can require a higher starting margin than the Fed minimum.
- Initial margin requirements are not the same as maintenance margin requirements. Maintenance margin requirements are the amount of equity that must always be kept in the account.
