Margin |
Initial Margin
When a trader enters into a new futures position, he does not pay the entire amount of the contract up front. Rather, both buyer and seller make an initial margin payment to the exchange. Margin (also called a performance bond) is a portion of the entire value of the contract which the exchange holds as security against losses a trader may suffer while his position is open. Initial margin is the amount debited from a trader’s account on initiation of a new position.
For example, on a contract with a notional value of $100,000, the initial margin may be set at $5,000, or %5 of the notional value.
For example, on a contract with a notional value of $100,000, the initial margin may be set at $5,000, or %5 of the notional value.
Maintenance Margin
While a trader holds an open position, the value of that position will fluctuate with market conditions. Consider the example of a trader who holds a long position in the August Gold contract for one lot. Each lot represents 100 oz of gold. He purchased the contract at a price of $1,265 per oz, so the notional value at the time of purchase was $126,500. Now let’s say the price of gold declines $5, to a last trade price of $1,260. If he were to sell the one contract now he could only get $126,000, so the notional value of his position has declined by $500.
At the end of day the exchange will debit his account $500 (a process called marking to market), to reflect the decline in value of his position. Maintenance margin is the minimum balance the trader must keep in his account to maintain the open position. For example with an initial margin of $5,000, the maintenance margin might be $4,000. If the value of his account were to drop below $4,000 as the price of gold declines, the trader would need to deposit extra capital or risk having the exchange close out his position automatically. When the value of a trader’s account gets dangerously low the exchange will issue a margin call requesting more funds.
The reverse happens when the value of a trader’s position increases. If after purchasing the gold contract at $1,265 the price went up to $1,270, the trader’s account would be credited an additional $500. As the price continues to rise the trader will accumulate excess capital in his account above and beyond the margin requirements, which he is free to withdraw and invest elsewhere.
At the end of day the exchange will debit his account $500 (a process called marking to market), to reflect the decline in value of his position. Maintenance margin is the minimum balance the trader must keep in his account to maintain the open position. For example with an initial margin of $5,000, the maintenance margin might be $4,000. If the value of his account were to drop below $4,000 as the price of gold declines, the trader would need to deposit extra capital or risk having the exchange close out his position automatically. When the value of a trader’s account gets dangerously low the exchange will issue a margin call requesting more funds.
The reverse happens when the value of a trader’s position increases. If after purchasing the gold contract at $1,265 the price went up to $1,270, the trader’s account would be credited an additional $500. As the price continues to rise the trader will accumulate excess capital in his account above and beyond the margin requirements, which he is free to withdraw and invest elsewhere.