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

Related Articles
  1. Investing

    Buying on Margin

    When an investor buys on margin, he or she pays a portion of the stock price – called the margin -- and borrows the rest from a stockbroker. The purchased stocks then serve as collateral for ...
  2. Financial Advisor

    Margin Investing Gets A Bad Rap, But For The Thrill-Seeker, It's Worth It

    Investing on margin can be profitable but it's a risky play that needs care.
  3. Investing

    Spreading The Word About Portfolio Margin

    An underused opportunity provided in an SEC rule can enhance returns and lower risk for spread traders.
  4. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look.
  5. Investing

    Finding Your Margin Investment Sweet Spot

    Borrowing to increase profits isn't for the faint of heart, but margin trading can mean big returns.
Frequently Asked Questions
  1. What are the Differences Among a Real Estate Agent, a broker and a Realtor?

    Learn how agents, realtors, and brokers are often considered the same, but in reality, these real estate positions have different ...
  2. What is the difference between amortization and depreciation?

    Because very few assets last forever, one of the main principles of accrual accounting requires that an asset's cost be proportionally ...
  3. Which is better, a fixed or variable rate loan?

    A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest ...
  4. What is the 1003 mortgage application form?

    Learn about the 1003 mortgage application form, what information it requires and why this form is the industry standard for ...
Trading Center