The amount required by the exchange to open a futures position is known as initial margin. Your broker may be needed to collect more monies for deposit while the exchange establishes the margin amount. The minimal amount that must be kept in your account at any one time is known as the maintenance margin.
What is the starting point?
- When using a margin account, the initial margin is the percentage of the purchase price that must be paid in cash.
- The initial margin must currently be set at a minimum of 50% of the security’s purchase price, according to Federal Reserve regulations. Brokerages and exchanges, on the other hand, are free to set initial margin requirements that are greater than the Fed’s minimum.
- Initial margin requirements are distinct from maintenance margin requirements, which refer to the percentage of equity that must be kept in the account on an ongoing basis.
What does the initial margin serve?
Initial margin is one of two types of collateral required in derivatives markets to protect a contracting party in the event that the other counterparty defaults.
The other sort of collateral is variation margin, which is paid daily from one side of the deal to the other in order to reflect the current market value of the contract. Initial margin is kept to protect the surviving party from losses that may occur between the defaulter’s last variation margin payment and the moment at which the trade can be hedged or replaced.
This duration varies between five and seven days in cleared trades, so starting margin on a large portfolio might become a hefty commitment.
When a deal is executed, IM is posted and then changed as needed throughout the life of the trade. Counterparties send IM to the clearing house in centrally cleared trades and to each other in non-cleared deals. Cash, government bonds, or letters of credit are the most common forms of payment.
What is the formula for calculating the starting margin?
To get the total purchase price, multiply the price per share by the number of shares you want to buy. Multiply the purchase price by the percentage of the initial margin needed. Assume you want to purchase 500 shares of a stock for $40 each. The cost of the purchase is $20,000. If you need a margin of 65 percent, multiply $20,000 by 65 percent to get a $13,000 beginning margin requirement.
What is an example of starting margin?
It’s worth noting that FX and commodities traders are permitted to open trades with far larger leverage. For example, if an investor wants to buy 1,000 shares of a stock at $10 per share, the total cost would be $10,000. Using a brokerage firm’s margin account, investors can buy 1,000 shares for as little as $5,000. The remaining $5,000 is covered by the brokerage firm. The loan is secured by the stock’s shares, and investors pay interest on the amount borrowed.
Is my original margin refunded?
If the account goes below the specified maintenance margin level in futures trading, the broker issues a margin call to the trader. This advises the trader that they must deposit sufficient funds to bring the account back up to the original margin level as soon as possible.
How are initial margin futures calculated?
Let’s go back to the forwards market scenario we used earlier (chapter 1). In the example given, ABC Jewelers agrees to buy 15 kilograms of gold from XYZ Gold Dealers for Rs.2450/- per gram in three months.
We can see that any change in the gold price will have a negative impact on ABC or XYZ. If the price of gold rises, XYZ will lose money, whereas ABC will profit. Similarly, if the price of gold falls, ABC loses money while XYZ profits. Furthermore, we are aware that a forwards agreement is based on a gentleman’s word. Consider a scenario in which the price of gold has skyrocketed, putting XYZ Gold Dealers in a tight predicament. Clearly, XYZ can claim that they are unable to make the required payment and hence default on the contract. Obviously, what follows will be a long and arduous legal battle, but that is outside our scope. It’s worth noting that the scope and motivation to default in a forwards agreement are both very great.
The default angle is carefully and intelligently dealt with in the futures market because it is an improvisation over the forwards market. Here’s where the margins come into play.
There is no regulation in the forwards market. The agreement is reached between two parties with no third party overseeing their transaction. In the futures market, however, all trades must pass via an exchange. In exchange, the exchange assumes responsibility for ensuring that all trades are settled. When I say ‘onus of guaranteeing,’ I mean that the exchange is responsible for ensuring that you receive your money if you are eligible. This also entails ensuring that the money is collected from the person that is obligated to pay.
So, how does the exchange ensure that everything runs smoothly? They accomplish this by employing
In the last chapter, we briefly discussed the idea of Margin. The concepts of margin and M2M must be understood in tandem in order to completely comprehend futures trading dynamics. However, because it’s impossible to describe both concepts at the same time, I’d want to take a break from margins and move on to M2M. We’ll learn everything there is to know about M2M before returning to margins. After that, we’ll revisit margins while keeping M2M in mind. However, before we go on to M2M, I’d like you to bear the following factors in mind:
- Margin is banned in your trading account at the time you start a futures position.
- The first margin consists of two parts: the SPAN margin and the Exposure Margin.
- The initial margin in your trading account will be frozen for the number of days you choose to hold the futures contract.
- The initial margin fluctuates on a daily basis, as it is determined by the futures price.
- The lot size is set, but the price of futures fluctuates every day. As a result, the margins change on a daily basis.
So, for the time being, remember only these points. We’ll go ahead and learn about M2M before returning to margins to finish this chapter.
Is the initial margin different every day?
Margins, or performance bonds, are changed often across all of our products as part of our risk management program in response to market volatility. We often boost margins to account for higher risk when daily price movements become more volatile.
When a counterparty or customer posts non-regulatory mandated independent amounts (Non Reg IA) that falls inside the scope of initial margin (Reg IM), the parties must agree on how they will recognize and treat these two margin flows in the future.
The ISDA 2018 initial margin document templates define three alternative Margin Approaches for determining the interaction between the amount of Reg IM and Non-Reg IA that will need to be traded on a particular day by in scope parties. The two parties must agree to adopt one of the three approaches for their daily margin calls when negotiating a regulatory compliant IM collateral document. The three ways are as follows:
Distinct Margin Flow (IM) Approach
- Parties who use the distinct margin flow technique will determine the amount of Reg IM that will need to be transferred in general without reference to or interaction with any Non-Reg IA that must be posted.
- The Reg IM collateral procedure will operate concurrently with the Non-Reg IA collateral process, with the two collateral calls being settled separately for any party that posts both Reg IM and Non-Reg IA collateral (which could be held in the same custodian account if the Non-Reg IA is segregated)
- Whether the Non-Reg IA is sent directly to Credit Suisse or separated at a custodian, the Distinct Margin Flow (IM) Approach can be applied. The Non-Reg IA is not required to comply with the IM regulations.
Allocated Margin Flow (IM/IA) Approach
- For trades covered by the same master agreement, the allocated margin flow strategy allows parties to lower their Non-Reg IA collateral call by the amount of their Reg IM requirement (minus any relevant threshold).
- All relevant transactions, including those covered by the Reg IM collateral instrument, should be covered by non-Reg IA collateral documents.
- The interplay between the two collateral amounts in the calculating process will not alter the settlement process any party that posts both Reg IM and Non-Reg IA will be settled with two separate collateral amounts.
- On a daily basis, collateral moves between Custodian-held regulatory IM and Credit Suisse-held IA may be required.
- Whether the Non-Reg IA is posted directly to Credit Suisse or segregated at a custodian, the Allocated Margin Flow (IM/IA) Approach can be utilised. The Non-Reg IA is not required to comply with the IM regulations.
Greater of Margin Flow (IM/IA) Approach
- For one master agreement, the “greater of” method combines the calculation of Reg IM and Non-Reg IA into a single collateral call per party. The larger of the Reg IM requirement (minus any relevant threshold) and any Non-Reg IA is used to determine this call. This is then settled as a single collateral call per party (covering both Reg IM and Non-Reg IA) and held in a custodian account.
- The Greater of Margin Flow (IM/IA) Approach can only be utilized if: I the Non-Reg IA is maintained in the same segregated custodian account as the Reg IM; and (ii) the Non-Reg IA complies with the Reg IM.
A variety of factors will influence which margin technique is best for a specific connection, including:
- Whether Non-Reg IA is applied uniformly to all transactions, as a fixed amount, or only to certain risks not covered by Reg IM.
What is the purpose of margin in futures trading?
A deposit used to secure a futures trade while it is open is known as margin money. The brokerage firm’s margins must be kept at a certain level. After the futures position is ended, the leftover margin money can be repaid to the account holder after transaction settlement.