Margin is earnest money deposited in cash (and occasionally the collateral value of the U.S. T-bills present in the investor’s account, a bank guarantee letter, or a letter of credit) an exchange requires an investor to have on account to establish and maintain positions in futures contracts.
Margin covers, at least partially, the potential liability from adverse price changes to the investor’s futures position.
Both initial and maintenance margin requirements are set by the board of directors of the exchanges and are changed mostly on the basis of volatility. Brokerage firms may set higher margin requirements than those set by exchange – and most do – but they may not set margins lower than exchange requirements.
What is initial margin?
What is maintenance margin?
The maintenance margin in futures trading is the minimum amount of money that must be present in a commodity contract at all times. If the margin prescribed by the exchange or brokerage firm in the position falls to or below a specified level (the maintenance level), a call for additional funds will be made in order to restore the account back up to the initial margin level. These funds are due the next business day.
Restating this definition, the maintenance margin is additional money that the customer has to deposit into the account if the market moves against him.
Both initial and maintenance margin requirements may change while a customer’s position is open. If so, the new requirements apply to both old and new positions. If a customer’s existing margin is sufficient to satisfy changed maintenance margin requirements, no additional funds need to be deposited. However, if it is not sufficient, additional funds must be deposited to satisfy the new initial margin requirement for open futures positions.
Permissible margin deposits
Cash or securities may be used for margin deposits. When using cash, 100% of the deposit is applied toward the margin. The market value of customer securities used as the margin are discounted by the set percentage to determine their margin collateral value. Discounting securities by a certain percentage (bonds by 10% or stocks by 25%) is known as haircutting.
The margin in the securities account must be maintained separately from the margin in a commodity account. Funds can be transferred between a customer’s securities and commodity accounts only if the customer has signed a written supplemental agreement, also called a funds transfer form.
Other types of margin in futures trading
Hedge margin vs speculative margins. The margin requirements for bona fide hedgers are typically lower than that for speculators. Because the hedgers handle the commodity, their risk of loss due to adverse price movements than that for speculators.
Spread margin. It is recognized that spread positions are less volatile than outright futures positions, so the spread margins are accordingly lower than for separate, individual futures contracts.
When buying or selling futures contracts, investors deposit a margin amount that serves as a good faith deposit. The margin requirements are lower for true hedgers than for speculators, because hedged positions have less risk.
In the commodity markets a trader may withdraw, at any time, any amount of equity in the account above the initial margin requirement. The withdrawal may even occur while the position remains open. The customer is not required to close out the position. The equity above the initial margin requirement is deemed a profit in the account. A withdrawal in this situation may be taken as cash or it may be applied to establish an additional futures position.
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