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.
How is the starting margin for 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.
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.
How is the initial margin determined?
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.
Is there a contract margin?
- The minimal account balance required by your broker to hold a single contract (long or short) during trading hours is known as intraday margin. The term “day trading margin” is also used to describe this.
- The initial margin required by the exchange to hold a position overnight is the per-contract minimum amount that must be kept in your account. Overnight margin is a term used to describe this.
*It’s vital to understand that mentioned margin rates are the absolute minimum required to retain a position, not the absolute minimum required to open a position. While position management is left to the discretion of the individual trader, it is advisable to give a trade plenty of breathing room to minimize margin violations. Financial leverage can result in losses that exceed the initial margin, therefore traders should be aware of the dangers associated with futures trading.
Carrying a Position Overnight
A long or short position that is not closed before the conclusion of the trading day is known as an overnight position. It’s critical to recognize the risks of holding a position overnight, such as the possibility of adverse price movement outside of regular trading hours.
Maintaining Appropriate Excess Margin
The amount of equity in a brokerage account that exceeds the minimum margin requirements is known as excess margin. Excess margin management is an important subject in futures trading since failing to maintain adequate margin levels might result in liquidation and/or fines from the broker.
- Liquidation, often known as an offset, is the process of closing out a long or short futures position. Liquidation occurs when the intraday margin is insufficient.
- A Margin Call is a request from your broker to increase your margin deposits to the required amounts in order to avoid full or partial liquidation. A margin call occurs when the initial margin is insufficient.
Trading with “full leverage” means there is no tolerance for error because there is no excess margin. If a trade moves one tick against you while trading at full leverage, your position is at risk of being forced liquidated by the trade desk. Any account that is in the red is regarded to be in breach of the margin rules and will be liquidated.
Trading contract sizes that are appropriate for your set risk levels and account size is, by and large, the simplest approach to handle excess margin.
- Use NinjaTrader’s Excess Margin account display to keep track of available margin right on the platform!
Position Limits
A position limit is a limit on the number of long or short contracts a trader can have at any given moment. These restrictions are in place to limit a trader’s total market exposure, and they are established by each market’s normal liquidity and volatility.
Margins Are Subject to Market Conditions
Both the exchange and the broker can modify margins at any time, especially during periods of extreme market volatility, with little or no notification to traders. Higher margin may be necessary to accommodate increasing risk. Margin requirements are frequently reduced back to previous levels when increased volatility lessens.
Practice Margin Maintenance with NinjaTrader
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In futures, who pays the initial margin?
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 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.
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.
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.
In futures, how does margin work?
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.