Derivatives - Futures Markets Margin

 

In the stock market, a margin is a loan that is made to the investor. It helps the investor to reduce the amount of her own cash that she uses to purchase securities. This creates leverage for the investor, causing gains and losses to be amplified. The loan must be paid back with interest.

  • Margin % = Market Value of the stock - Market value of the debt divided by the market value of the stock
  • An initial margin loan in the U.S can be as much as 50%. The market value of the securities minus the amount borrowed can often be less than 50%, but the investor must keep a balance of 25-30% of the total market value of the securities in the margin account as a maintenance margin.

A margin in the futures market is the amount of cash an investor must put up to open an account to start trading. This cash amount is the initial margin requirement and it is not a loan. It acts as a down payment on the underlying asset and helps ensure that both parties fulfill their obligations. Both buyers and sellers must put up payments.

Initial Margin
This is the initial amount of cash that must be deposited in the account to start trading contracts. It acts as a down payment for the delivery of the contract and ensures that the parties honor their obligations.

Maintenance Margin
This is the balance a trader must maintain in his or her account as the balance changes due to price fluctuations. It is some fraction - perhaps 75% - of initial margin for a position. If the balance in the trader's account drops below this margin, the trader is required to deposit enough funds or securities to bring the account back up to the initial margin requirement. Such a demand is referred to as a margin call. The trader can close his position in this case but he is still responsible for the loss incurred. However, if he closes his position, he is no longer at risk of the position losing additional funds.

Futures (which are exchange-traded) and forwards (which are traded OTC) treat margin accounts differently. When a trader posts collateral to secure an OTC derivative obligation such as a forward, the trader legally still owns the collateral. With futures contracts, money transferred from a margin account to an exchange as a margin payment legally changes hands. A deposit in a margin account at a broker is collateral. It legally still belongs to the client, but the broker can take possession of it any time to satisfy obligations arising from the client's futures positions

Variation Margin
This is the amount of cash or collateral that brings the account up to the initial margin amount once it drops below the maintenance margin.

Settlement Price
Settlement price is established by the appropriate exchange settlement committee at the close of each trading session. It is the official price that will be used by the clearing house to determine net gains or losses, margin requirements and the next day's price limits. Most often, the settlement price represents the average price of the last few trades that occur on the day. It is the official price set by the clearing house and it helps to process the day's gains and loses in marking to market the accounts. However, each exchange may have its own particular methodology. For example, on NYMEX (the New York Mercantile Exchange) and COMEX (The New York Commodity Exchange) settlement price calculations depend of the level of trading activity. In contract months with significant activity, the settlement price is derived by calculating the weighted average of the prices at which trades were conducted during the closing range, a brief period at the end of the day. Contract months with little or no trading activity on a given day are settled based on the spread relationships to the closest active contract month, while on the Tokyo Financial Exchange settlement price is calculated as the theoretical value based on the expected volatility for each series set by the exchange.
 

Look Out!
Remember that settlement price is NOT the closing price
.

 

The Futures Trade Process


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