|
Understanding
Margin
Margins are determined on the
basis of market risk. Because margins are adjusted to risk, they help to
assure the financial soundness of futures exchanges and provide valuable
price protection for hedgers with a minimum tie-up of capital. Margins are
typically set at 4 to 18 percent of the value of the commodity underlying
the futures contract and assessed each day depending upon the settlement
of the underlying futures market in a process known as Marked to Market.
The exchange has set two types
of Margin Requirements:
For example, assume that the
current margin on a Soybean contract is $1,148 Initial and $850 Maintenance.
A trader would need to have at least $1,148 per futures contract in
his/her account in order to initiate a futures position. Once the
initial margin requirement is met, the trader must maintain an account
balance of $850 in order to continue to hold the position.
Assume for a moment that a
trader has a $5,000 account and wishes to buy 3 November Soybean
contracts. Since the trader's account is greater than initial margin
requirement (3 contracts x $1,148, or $3,444), he/she can initiate the
position. The $3,444 in initial margin is NOT removed from the
traders account, but it is applied towards the maintenance margin.
At all times the trader is in this position, the account balance -
reflecting open position profits and losses - must stay above the
Maintenance Margin Require (or 3 contracts x $850 = $2,550).
Assuming that the trader
bought 3 contracts at $7.00/bushel, the trader has $0.17 per bushel in
excess margin. For example, if Soybeans were to drop from
$7.00/bushel to $6.83/bushel, the trader would have an open position loss
of -$2,550 before commissions and fees, and an account balance of $2,550.
Since the difference between the maintenance margin requirement of $2,550
and the account balance of $2,550 is nothing, the trader would be on a
MARGIN CALL.
When faced with a margin call,
the trader has two options. The trader can either liquidate the
position - taking the loss - or deposit sufficient funds to bring the
account balance back above the Initial Margin Requirement.
When faced with a margin call,
traders usually have 24 hours to meet the call by wiring money into their
account. Sinclair & Company and PFG have the right to liquidate the
position at any time a margin call is made, and margin requirements are
subject to change without notice, and traders must always meet margin
requirements in a prompt fashion.
The best way to avoid margin
calls is to be sufficiently capitalized. Do not over trade, and
remember that it is possible to loose more than account balance.
On the other hand, if the
trader who bought 3 contracts at $7.00/bushel saw Soybeans increase from
$7.00/bushel to $7.17/bushel, the trader would have an open position
profit of +$2,550 before commissions and fees, and an account balance of
$7,550, and an excess account balance of $5,000 due to the open position
profits. The trader is free to withdraw these funds, or to use these
excess funds to add to a position.
Margin is what gives futures
the tremendous leverage. Leverage is a two edged sword, and can be a
wonderful thing when the markets are moving in your direction, however
leverage also increases losses when they are not. Traders should
always respect the markets and remember not to risk too much at one time
as futures trading involves substantial risk.
|
