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Initial vs Maintenance Margin for a Futures Contract: What’s the Difference?

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. 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.

  1. The maintenance margin exists to protect brokerage firms from investors defaulting on their loans.
  2. The two both relate to the amount of cash vs. the amount you can borrow when investing.
  3. But if the asset increases in price, traders can potentially profit on the stock, earning a greater return than if they just paid in full with a cash account.

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 forex trading fundamentals 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.

If your initial margin is 50%, your purchasing power multiplier is 2. Consequently, if you contribute an initial margin of $8,000, your total purchasing power becomes $16,000. An investing platform can provide more clarity regarding the mechanics of these sorts of trades, along with tools and resources to hone your investing strategy. But the following overview can give you a better understanding of initial margin requirements and how they may fit into your financial plan. If the price of the stock drops, the investor will be paying interest to the brokerage firm in addition to making larger losses on the investment. An initial margin is used as the trader’s contribution when buying assets on margin, and the broker provides the remainder of the purchase.

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.

Option Trading

The stocks the trader has purchased then serve as collateral for the loan. An investor who buys stocks on margin must establish a margin account with their broker, which allows them to borrow funds from their broker without paying the full value for each trade. 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 futures trading, if the account falls below the specified maintenance margin level, then the broker sends the trader a margin call.

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.

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 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.

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.

But if the asset increases in price, traders can potentially profit on the stock, earning a greater return than if they just paid in full with a cash account. The Federal Reserve’s Regulation T sets the rules for margin requirements. There is an initial margin requirement, which represents the https://www.forexbox.info/top-10-ways-to-invest-money/ margin at the time of the purchase. There is also a maintenance margin requirement, which represents the minimum amount of equity needed in the margin account to keep the position open. In margin trading, you’ll contribute your own funds but also borrow from the broker’s contributions.

What is the initial margin used for?

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 https://www.day-trading.info/quantitative-trading-strategies-quantitative/ 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.

Initial vs. Maintenance Margin for a Futures Contract: An Overview

This informs the trader that they must immediately deposit sufficient funds to bring the account back up to the initial margin level. If the trader fails to do so promptly, the broker will close out the trader’s market position. The broker always sets the initial margin requirements, most commonly expressed as a percentage of the total margin.

If you contribute your full $7,000, your total purchasing power rises to $15,000. For example, if you put up $10,000, the broker will also contribute $10,000, raising your margin purchasing power to $20,000. But that doesn’t mean it’ll fully fund the purchase — you’ll have to put up money of your own to get started. These funds are known as the initial margin, and the amount can vary based on your lender and the amount of margin you receive. When trading on margin, an investor should also consider the interest or other fees charged by their broker in order to calculate the true cost of the trade and the profit or loss potential.

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 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.

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.

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