Margin is the earnest money deposited in cash (and sometimes includes collateral like U.S. T-bills, a bank guarantee letter, or a letter of credit) that an exchange requires to open and maintain positions in futures contracts.
This margin serves to cover, at least partially, the potential liability from adverse price changes affecting the investor’s futures position.
Both initial and maintenance margin requirements are determined by the exchange’s board of directors and are typically adjusted based on market volatility. Brokerage firms may set higher margin requirements than those established by the exchange, but they cannot set margins lower than the exchange’s minimum requirements.
Margin is not a “down payment.” The volatility and price of a contract are used to determine its minimum margin requirement.
What is initial margin?
Looking to grow your wealth?
Let me help you make your money work for you
Managed Investment Accounts – harness the expertise of professional asset management. I’ll focus on growing your wealth, so you can focus on living your best life.
Automated Trading System – effortlessly grow your capital with our automated trading solutions
As previously mentioned, margin in commodities serves solely as a performance guarantee, so there are no margin interest costs, as there is no actual possession of the underlying commodity.
Unlike security margin requirements, which are often a percentage of the contract value (e.g., 50% for stocks), margin requirements for futures are predetermined dollar amounts (e.g., $1,320 per live cattle contract).
Excess margin can be used to open new positions, transferred to another account (stock, securities), or withdrawn by the client. The client doesn’t have to close the position to remove excess margin.
What is the maintenance margin?
The maintenance margin in futures trading is the minimum amount of money that must be maintained in a commodity account at all times. If the margin in the position falls to or below this maintenance level, a margin call will be issued, requiring the customer to deposit additional funds to restore the account to the initial margin level. These additional funds are typically due by the next business day.
In other words, the maintenance margin is the extra money that must be deposited if the market moves unfavorably against the position.
Both initial and maintenance margin requirements can change while a position is open. If the margin requirements are adjusted, the new requirements apply to both existing and new positions. If the existing margin is sufficient to meet the revised maintenance margin, no additional funds are required. However, if it is insufficient, additional funds must be deposited to meet the new initial margin requirements for open futures positions.
Initial margin vs maintenance margin example:
A customer has an account with one position with an initial margin requirement of $1000 and a maintenance margin of $500. If the equity in the account falls below $500, the customer must deposit sufficient funds to restore the account value to $1000.
Permissible margin deposits
Cash or securities can be used for margin deposits. When cash is used, 100% of the deposit is applied toward the margin. For securities, their market value is discounted by a set percentage to determine their margin collateral value. This process of discounting securities, such as bonds by 10% or stocks by 25%, is known as haircutting.
The value of the security that can be used for the margin is the complement of its haircut. For example, if bonds receive a 20% haircut, then 80% of the bond’s value can be used to margin futures positions. If stocks receive a 25% haircut, then 75% of the stocks’ value can be used to margin futures positions.
Margin in a securities account must be kept separate from the margin in a commodity account. Funds can only be transferred between a customer’s securities and commodity accounts if the customer has signed a written supplemental agreement, also known as a funds transfer form.
Hedge vs speculative margins
Margin requirements for bona fide hedgers are generally lower than those for speculators. This is because hedgers, who handle the commodity, face less risk of loss from adverse price movements compared to speculators.
Spread Margin
Spread positions, which involve taking offsetting positions in different futures contracts, are less volatile than outright futures positions. As a result, margin requirements for spread positions are typically lower than those for individual futures contracts.
In conclusion
When buying or selling futures contracts, investors deposit a margin amount as a good faith deposit. Margin requirements are lower for genuine hedgers compared to speculators because hedged positions carry less risk.
In commodity markets, traders can withdraw any amount of equity in the account that exceeds the initial margin requirement at any time, even while the position remains open. The customer is not required to close the position. The excess equity is considered profit and can be withdrawn as cash or used to open additional futures positions.
Wishing you a great week!
Want Your Money To Grow?
Subscribe to get free research, trading lessons, and more insights.
(We do not share your data with anybody, and only use it for its intended purpose)
