Initial vs. Maintenance Margin for a Futures Contract: An Overview
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, but also losses.
- A futures contract is a financial derivative that locks in a price today of some underlying asset to be delivered in the future.
- These contracts are marginable, meaning that a trader only needs to put up a portion of the total notional value of the trade, known as the initial margin.
- If the price of the underlying falls, the trader will have to come up with more money, known as maintenance margin, in order to keep the trade active.
The initial margin is the initial amount of money 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 futures contracts, exchanges set initial margin requirements that can be as little as 5% or 10% of the contract to be traded.
For example, a crude oil contract futures contract on the Chicago Mercantile Exchange (CME) is for 1,000 barrels of oil. At $75 per barrel, the notional value of the contract is $75,000. A trader, however, 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.
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 our 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.