The Basics of the Initial Margin Requirements

Contributor, Benzinga
October 16, 2023

Investing requires funding. If you find yourself coming up short, an investment broker will commonly allow you to purchase stocks or other assets on margin.

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.

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.

Initial Margin Explained

Investment brokers typically extend a loan to investors by opening a margin account. The amount of margin varies by the broker, but a 50-50 split is common. In other words, when you buy an asset, you and the broker will share the cost.

For example, if you put up \$10,000, the broker will also contribute \$10,000, raising your margin purchasing power to \$20,000. The amount you contribute is the initial margin.

In this example, the initial margin is 50% of the total purchasing power, though it can vary depending on the percentage of the margin the broker extends.

Initial Margin Formula: How to Calculate

How do you calculate the initial margin? Use this simple initial margin formula:

Initial Margin = (Initial margin requirement set by the authority) x (Total purchase price)

Imagine you want to buy \$20,000 worth of Company XYZ, and a broker has a margin requirement of 75%. Here’s how to calculate your initial margin:

Initial Margin = (0.75) x (\$20,000)

Initial Margin = \$15,000

Thus, to purchase this many shares, you’ll have to contribute \$15,000, and the broker will provide an additional \$5,000.

If your broker permits margin trading, it’ll specify an initial margin requirement, which will be expressed as a percentage. 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.

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. This will often be a 50-50 split, though it can vary by broker.

Options margins work a bit differently. 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.

Purchasing Power Multiplier = 1 / (Initial Margin)

If, on the other hand, your initial margin is 25%, your purchasing power multiplier is 4. By contributing an initial margin of \$8,000, your total purchasing power climbs to \$32,000.

More Examples

Got all that? If you’re still hazy, some additional practice might help.

Imagine you want to purchase shares of Company ABC but only have \$7,000 to spend. Your investment broker allows you to open a margin account, requiring an initial margin of at least 40%. Using the formula above, you can calculate the purchasing power multiplier as follows:

Purchasing Power Multiplier = 1 / (0.40)

Initial Margin vs. Maintenance Margin

How best to understand initial margin vs. maintenance margin?

Brokers protect themselves from losses by requiring a maintenance margin. In fact, the Financial Industry Regulatory Authority (FINRA) requires a minimum maintenance margin of 25%, though some brokers will charge more.

If the value of an asset drops below the margin maintenance requirement, the broker may perform a margin call to request that you deposit additional funds or sell enough assets to cover the call.

The margin maintenance value is equal to the following:

Margin Account Value = (Margin Loan) / (100% - Maintenance Margin %)

If your broker offers a 50% margin, and you contribute an initial margin of \$8,000, your margin loan is also \$8,000. Assuming a standard 25% maintenance margin requirement, the formula becomes:

Margin Account Value = (\$8,000) / (100% - 25%)

Thus, the maintenance margin requirement becomes \$10,666. 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.

Most brokers specify a maintenance margin, which refers to the minimum equity investors must have in their margin accounts after each trade.

Currently, FINRA requires that the maintenance margin be set to a minimum of 25%. However, brokers can ask for a higher margin requirement for certain volatile stocks and assets.

In margin trading, you’ll contribute your own funds but also borrow from the broker’s contributions. The goal is to leverage this additional purchasing power to potentially increase your earnings. The downside to using margin is that if the stock price decreases, substantial losses can occur quickly. Moreover, an investor could potentially lose more than 100% of their initial investment, plus any interest that accrues from borrowing money.

Q

What is the initial margin used for?

A

An initial margin is used as the trader’s contribution when buying assets on margin, and the broker provides the remainder of the purchase.

Q

Who sets initial margin requirements?

A

The broker always sets the initial margin requirements, most commonly expressed as a percentage of the total margin.

Q

Is the initial margin returnable?

A

Not exactly. 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. 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.