A:

The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have a very high value, a trader can buy or sell the contract with a much smaller amount, which is known as the initial margin.

The initial margin is essentially a down payment on the value of the futures contract and the obligations associated with the contract. Trading futures contracts is different than trading stocks due to the high degree of leverage involved. This leverage can amplify profits and losses.

Initial Margin

The initial margin is the initial amount of money that a trader must place in an account to open a futures position. The amount is established by the exchange and is a percentage of the value of the futures contract.

For example, a crude oil contract futures contract is 1,000 barrels of oil. At $75 a barrel, the notional value of the contract is $75,000. A trader is not required to place this amount into an account. Rather, the initial margin for a crude oil contract could be around $5,000 per contract as determined by the exchange. This is the initial amount the trader must place in the account to open a position.

Maintenance Margin

The maintenance margin amount is less than the initial margin. This is the amount the trader must keep in the account due to changes in the price of the contract.

In this oil example, assume the maintenance margin is $4,000. If a trader buys an oil contract and then the price drops $2, the value of the contract has fallen $2,000. If the balance in the account is less than the maintenance margin, the trader must place additional funds to meet the maintenance margin. If the trader does not meet the margin call, the broker or exchange could unilaterally liquidate the position.

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