What is Initial Margin
Initial margin is the percentage of the purchase price of securities (that can be purchased on margin) that the investor must pay for with his own cash or marginable securities. According to Regulation T of the Federal Reserve Board, the initial margin is currently 50% of the purchase price of securities that can be purchased on margin, but this level is only a minimum and some brokerages require you to deposit more than 50%. For futures contracts, initial margin requirements are set by the exchange.
Initial margin is sometimes called the initial margin requirement.
BREAKING DOWN Initial Margin
A margin account encourages investors to use leverage to purchase more securities than the cash balance in their account would allow. A margin account is essentially a loan account in which interest is charged on the outstanding margin balance. The securities purchased in the margin account are purchased with cash loaned to the investor by the broker, and the securities themselves are used as collateral. This allows for a potential magnification in gains, but also losses. In the extreme event that the securities purchased on margin decline to zero, the investor would need to deposit the full initial value of the securities in cash to cover the loss.
Initial Margin Requirements and Example
To use a margin account, an investor needs to post a certain amount of cash, securities or other collateral, known as the initial margin requirement. In most cases, for equity securities, the initial margin requirement is 50%. As an example, assume an investor wants to purchase 1,000 shares of Facebook, Inc. which is priced at $200 per share. The total cost in a cash balance account would be $200,000. However, if the investor opens a margin account and deposits the 50% initial margin requirement, or $100,000, he would have a total purchasing power of $200,000. This is how leverage is created, in this case a two-to-one leverage amount.
For futures contracts, the exchanges set the initial margin requirements, but often it is as low as 5% or 10% of the contract to be traded. For example, if an oil futures contract is $100,000, an investor can enter into that position by posting only $5,000 initial margin. This initial margin requirement would give the investor a 20x leverage factor. During periods of high market volatility, the exchanges may increase initial margin requirements to any level they deem appropriate, and brokers may decide to increase initial margin levels above those required by law.
Initial margin requirements are not the same as maintenance margin requirements, which also may be increased or decreased based on market volatility.