Why are margins required when buying or selling a futures contract? Futures trading is risky since price movements can go against you. If you buy Nifty futures at a price of 10,300 and the Nifty drops to Rs.10,200, you will lose money, and that is the risk you are taking. Markets are inherently volatile, and these margins are essentially gathered to mitigate the risk of market volatility. So, what exactly is futures margining and how does it work? In general, there are two sorts of margins that are gathered. You must pay the Initial Margin on the trade (SPAN + Exposure margin) at the time of taking the position.
The SPAN margin is calculated using the VAR statistical concept (Value at Risk). Essentially, the initial margin should be wide enough to absorb the loss of your position in 99 percent of circumstances. There will be days when the Black Swan appears, but that is a separate matter. The initial margin is calculated using the portfolio’s maximum possible loss in a single day. The higher the stock’s volatility, the higher the risk, and thus the higher the initial margin. The mark-to-market (MTM) margin, which is collected for daily fluctuation in the price of futures, is the second form of margin. The first margin only considers the danger of a single day. If the stock continues to move against you (falling when long, rising when short), the MTM will be collected on each succeeding day. So, how does the futures margin in practice work? Let’s look at a live example of Initial Margins and MTM margins to learn more about margins on futures contracts.
The starting margin is calculated as the total of the SPAN and Exposure margins in the chart above. The stock exchange determines the minimum margins required for each given position. Brokers are allowed to collect more than this margin, but they are not allowed to collect less. The ACC contracts for November, December, and January are considered in the table above. As the contract matures further into the future, the margins will increase due to increased risk. The three types of initial margins levied by the broker on your futures account are what matters here. Let’s look at the specifics of this futures margin example.
This is the standard margin that must be charged if you want to carry your futures trade ahead beyond the day. Depending on the risk and volatility of the stock, the initial margin for a Carry Forward trade typically ranges from 10% to 15% of the contract’s notional value. In the example above, the notional value of the futures contract for the November 2017 contract is Rs.708,580/- (1771.45 X 400). The initial margin is collected at Rs.89,338/- per lot on that notional value, which works out to 12.61 percent of the notional value. As previously stated, the percentage of initial margin for a futures position will be determined by the stock’s volatility and risk.
The standard margin is for a futures position that you intend to continue over to the next day. But what if you want to close the position inside the day? The initial margins (MIS) will be lower because the risk is lower. The initial margin for intraday index futures is set at 40% of the usual initial margin, whereas the initial margin for intraday stock futures is set at 50% of the normal initial margin. In the example above, the margin will be half of the regular margin, or Rs.44,669/-. Margin Intraday Square-off (MIS) margin is the name given to this margin.
The BO/CO margin is the third category, and it is even lower than the MIS margin. The Bracket Orders and Cover Orders are the two types of orders. The intraday trade in a cover order is required to have an in-built stop loss. The Bracket Order takes it a step further by defining a stop loss as well as a profit target, resulting in a closed bracket order. The margin in this situation will be 30-33 percent of the typical margins, which is Rs.28,343/- in the case of ACC.
One thing to keep in mind is that in the case of MIS orders, CO orders, and BO orders, your broker’s risk management system (RMS) will typically close out any open positions 15-30 minutes before the close of stock market trading on the same day.
MTM (Mark to Market) margin is a type of accounting adjustment. If you bought Tata Motors futures at Rs.409, you don’t have anything to worry about as long as the price stays over Rs.409. When Tata Motors’ market price falls below Rs.409, the MTM problem would arise. There are two scenarios here as well. To begin, most brokers will verify if your margin amount is sufficient to cover the SPAN margin if the price drops to Rs.407 or lower. (Remember that SPAN + Exposure Margin equals Initial Margin.) That’s still fine. If the stock price falls below Rs.395, on the other hand, your margin balance is likely to go below the SPAN Margin. The broker will then issue a Margin Call, requesting that you settle the margin deficit, and if you are unable to do so, your position will be closed out by the RMS. MTM margins only apply to carry forward contracts; they do not apply to intraday, BO, or CO positions.
So that’s everything there is to know about margins in futures contracts. The example of futures margins above demonstrates how futures margins function in practice. In a nutshell, it’s a risk mitigation strategy!
What is the definition of beginning margin and how is it calculated?
- 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 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.
How are initial and maintenance margins calculated?
The initial margin in the offered maintenance margin example is 50 percent (the federal minimum), and the maintenance margin is 25 percent (the FINRA regulatory minimum). If you borrow $50 to buy an asset for $100, the margin call price is $100 * (1 – 50%)/(1 – 25%) = $100 * 0.50/0.75 = $66.67. That means that if the security is trading at $66.67 and you borrowed $50 of that, your equity is just $16.67. That’s 25 percent of the security’s value ($16.67/$66.67), with the firm’s lent money accounting for 75 percent of the investment ($50/$66.67).
What is the definition of initial margin futures?
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 margin required formula?
Margin Requirements Calculation Multiply the number of shares X the price X the margin rate to find the margin necessary for a lengthy stock buy. A short sale’s margin requirement is the standard margin requirement plus 100 percent of the security’s value.
What is the minimum beginning margin?
An initial margin, also known as an initial margin requirement, is the cash amount that an investor must pay for stocks before a broker can lend that investor money to acquire other securities.
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.
On FTX, how do you handle leverage?
You can also use the ‘CONVERT’ tool to buy or sell leveraged tokens directly from your wallet page. If you locate a token and click the ‘CONVERT’ button on the right side of the screen, you’ll be sent to a dialog box where you can simply convert any of your FTX coins into the leveraged token.