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

what is initial margin

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. Securities in the margin account are paid for with cash loaned to the account holder by the brokerage firm and are designated as collateral.

The Differences Between Day & Initial Margin in Futures

Primarily it initiates the leveraged trading process enabling the opening of larger positions using minimum capital from the investor end. In addition, it acts as collateral to the brokerage firm, and the investors benefit by having increased purchasing power since they can buy more securities which otherwise not affordable. In futures, it means the amount charged by the stock exchange to initiate a futures position. It is only done through a margin account created with the stock exchange as per the margin regulations. In contrast, the initial margin requirement for securities, in general, is approximately 50%. Initial margin refers to the equity to be contributed by the investor trading on margin to the margin account, and it is expressed as a percentage of the total purchase price.

Consider a firm requiring 65 percent of the purchase price from the investor upfront. That would cover no more than $3,500 with a loan, meaning the investor would need to pay $6,500. In contrast, the maintenance margin is the amount of equity that must be kept in the margin account going forward. That means an investor must maintain enough cash or collateral value in the 10 best oil and gas stocks for this year account to cover 25% of the securities owned.

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.

You are exposed to the bank and are facing a potential loss if they default and fail to pay what they owe you. If the value of the trade shifts in your favor far enough (above the MTA), the bank will transfer variation margin to you, reducing your exposure. Both initial margin and variation margin ensure both parties are adequately covered against potential losses.

When are you required to pay an initial margin?

what is initial margin

In contrast, variation margin protects both parties in a transaction from their current exposures. Mark-to-market tells you how the fair value of an asset fluctuates every day. These daily mark-to-market valuations usually follow well-recognized industry calculation methodologies. Regulations do not allow ges partners with ads securities to offer deep liquidity netting the requested and the posted initial margin.

Initial Margin vs. Variation Margin for OTC Derivatives

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. It starts with attaining the minimum margin requirement before trading on margin starts. For example, in the United States, the investor has to deposit $2000 or 100 percent of the purchase price, whichever is less to attain the minimum margin. It is followed by the initial margin requirement that is trading by providing 50% of the purchase price in cash and the remaining 50% financed through borrowing from the brokerage entity. The initial margin requirement is the amount a trader must deposit to initiate a trading position.

Initial Margin vs. Maintenance Margin

  1. With that said, brokers and dealers may require a higher margin if they deem the investor to be riskier.
  2. However, if the market moves against the trader’s position, a moderate price shift amplified by the leverage used can lead to losses greater than the trader’s margin deposit.
  3. The actual amount will depend upon the broker’s requirements and some brokers may require the trader to have more than 50% on deposit.

Initial margin is a risk-based calculation, while the variation margin calculation is based on the market values of trades. Say you’re a bank and your counterparty in a derivatives trade defaults. For trades cleared through a central counterparty clearing house (CCP), firms post initial margin to the clearing house. The goal was to reduce systemic risk by ensuring collateral is available to offset losses caused by the default of a counterparty in a derivatives contract. Initial margin is paid upfront and serves as an extra layer of protection against delays in getting rid of collateral in the case of counterparty default.

Difference between Initial Margin and Variation Margin

The initial margin for stocks at U.S. brokerages must be at least 50 percent, according to Regulation T. Note that forex and commodities traders are allowed to establish positions using much more leverage. If an investor wants to purchase 1,000 shares of a stock valued at $10 per share, for example, the total price would be $10,000. A margin account with a brokerage firm allows investors to acquire the 1,000 shares for as little as $5,000.

Anything above that threshold and the MTA is variation margin to be paid. It eliminates the need for each firm to develop its own margin calculation methodology. The initial margin required is usually the sum of the top couple of losses, or a result selected according to the confidence interval wanted (usually 90-99%). Usually, the recipient of initial margin cannot reuse it for new investments. Instead, the amounts are segregated and go to a custodian who holds the posted collateral.

But in general, the ISDA SIMM results in lower margin requirements. The riskier the derivatives portfolio, the higher the initial margin the SIMM will suggest the bank demands from its counterparty. There are always two separate initial margin transfers between firms.

Additionally, initial margin should be segregated (meaning paid to a custodian, as opposed to directly between counterparties) and cannot be reused for investment purposes. A party only has exposure to the other if the market value of derivatives contract moved in its favor. The counterparty losing the trade at the time owes money, so they have no exposure. Initial margin protects both parties against the potential future exposure of the other. This exposure is a result of future fluctuations in the price of the underlying asset of the contract. And when the exposure is above the Minimum Transfer Amount (MTA), the loser of the trade at the time will post variation margin to the winner.

In futures trading, if the account falls below the specified maintenance margin level, then the broker sends the trader a margin call. 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 maintenance margin exists to protect brokerage firms from investors defaulting on their loans. Keeping a buffer between the 6 “best” online stock brokers for beginners amount of the loan and the value of the account lessens the firm’s risk.

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