A tool named SPAN is used by exchanges to determine futures margin rates. This application calculates a final amount for initial and maintenance margin in each futures market based on a variety of factors. The volatility of each futures market, or how stable (or unstable) it might be in the future, is the most important factor in determining margins. Market factors cause the exchanges’ margin settings to vary.
In futures, how is margin 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.
What is futures margin?
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.
How do you figure out your selling margin?
Although various firms calculate their sales margin differently, the sales margin is the final selling price of the product or service minus the entire cost of the product or service. Here are some methods for calculating sales margin:
To calculate the net profit, subtract the total cost of the product from the total revenue.
Is it possible to trade futures without using margin?
Although you must have enough in your account to cover all day trading margins and variations that come from your positions, there is no legal minimum balance you must maintain to day trade futures. The day trading margins differ from broker to broker.
How do you figure out your initial 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 the purpose of futures contracts?
A futures contract is a legally enforceable agreement to acquire or sell a standardized asset at a defined price at a future date. Futures contracts are exchanged electronically on exchanges like the CME Group, which is the world’s largest futures exchange.
What is the formula for calculating notional value?
The notional value of a security is the whole amount of the underlying asset at the current market price. The notional value separates the amount of money invested from the total amount of money involved in the transaction. Multiplying the units in one contract by the current price yields the notional value.
How can you figure out what a stock’s future price will be?
To figure out what a stock’s estimated future price will be, divide the annual dividend payout by the present stock price. If a stock is now trading at $80 and pays a $3 annual dividend, you would divide $3 by $80 to obtain 0.0375. To get the stock’s expected growth rate, multiply the projected dividend growth rate by the expected dividend growth rate. If the expected dividend growth rate was 5%, your stock would have an expected growth rate of 0.0875 in the preceding step’s example. 1.0875 is the result of adding 1 to the predicted growth rate of 0.0875.
How do you make money trading futures?
The value of futures and options is determined by the underlying, which might be a stock, index, bond, or commodity. For the time being, let’s concentrate on stock and index futures and options. The value of a stock future/option is derived from a stock such as RIL or Tata Steel. The value of an index future/option is derived from an underlying index such as the Nifty or the Bank Nifty. F&O volumes in India have increased dramatically in recent years, accounting for 90 percent of total volumes in the industry.
F&O, on the other hand, has its own set of myths and fallacies. Most novice traders consider F&O to be a less expensive way to trade stocks. Legendary investors like Warren Buffett, on the other hand, have referred to derivatives as “weapons of mass destruction.” The truth, of course, lies somewhere in the middle. It is feasible to benefit from online F&O trading if you master the fundamentals.
1. Use F&O as a hedge rather than a trade.
This is the fundamental principle of futures and options trading. F&O is a margin business, which is one of the reasons retail investors get excited about it. For example, you can buy Nifty worth Rs.10 lakhs for just Rs.3 lakhs if you pay a margin of Rs.3 lakhs. This allows you to double your money by three. However, this is a slightly risky approach to employ because, just as gains can expand, losses in futures might as well. You’ll also need enough cash to cover mark-to-market (MTM) margins if the market moves against you.
To hedge, take a closer look at futures and options. Let’s take a closer look at this. If you bought Reliance at Rs.1100 and the CMP is Rs.1300, you may sell the futures at Rs.1305 and lock in a profit of Rs.205 by selling the futures at Rs.1305 (futures generally price at a premium to spot). Now, regardless of how the price moves, you’ve locked in a profit of Rs.205. Similarly, if you own SBI at Rs.350 and are concerned about a potential fall, you can hedge by purchasing a Rs.340 put option at Rs.2. You are now insured for less than Rs.338. You record profits on the put option if the price of SBI falls to Rs.320, lowering the cost of owning the shares. By getting the philosophy correct, you can make F&O operate effectively!
2. Make sure the trade structure is correct, including strike, premium, expiration, and risk.
Another reason why traders make mistakes with their F&O deals is because the trade is poorly structured. What do we mean when we say a F&O trade is structured?
Check for dividends and see if the cost of carry is beneficial before buying or selling futures.
When it comes to trading futures and options, the expiration date is quite important. You can choose between near-month and far-month expiration dates. While long-term contracts can save you money, they are illiquid and difficult to exit.
In terms of possibilities, which strike should you choose? Options that are deep OTM (out of the money) may appear to be cheap, but they are usually worthless. Deep ITM (in the money) options are similar to futures in that they provide no additional value.
Get a handle on how to value alternatives. Based on the Black and Scholes model, your trading terminal includes an interface to determine if the option is undervalued or overvalued. Make careful you acquire low-cost options and sell high-cost options.
3. Pay attention to trade management, such as stop-loss and profit targets.
The last item to consider is how you handle the trade, which is very important when trading F&O. This is why:
The first step is to put a stop loss in place for all F&O deals. Keep in mind that this is a leveraged enterprise, thus a stop loss is essential. Stop losses should ideally be included into the trade rather than added later. Above all, Online Trading requires strict discipline.
Profit is defined as the amount of money you book in F&O; everything else is just book profits. Try to churn your money quickly since you can make more money in the F&O trading company if you churn your capital more aggressively.
Keep track of the greatest amount of money you’re willing to lose and adjust your strategy accordingly. Never put more money on the table than you can afford to lose. Above all, stay out of markets that are beyond your knowledge.
F&O is a fantastic online trading solution. To be lucrative in F&O, you only need to take care of the three building components.