Futures Contract - Margin

Margin

To minimize credit risk to the exchange, traders must post a margin or a performance bond, typically 5%-15% of the contract's value.

To minimize counterparty risk to traders, trades executed on regulated futures exchanges are guaranteed by a clearing house. The clearing house becomes the buyer to each seller, and the seller to each Buyer, so that in the event of a counterparty default the clearer assumes the risk of loss. This enables traders to transact without performing due diligence on their counterparty.

Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or spread traders who have offsetting contracts balancing the position.

Clearing margin are financial safeguards to ensure that companies or corporations perform on their customers' open futures and options contracts. Clearing margins are distinct from customer margins that individual buyers and sellers of futures and options contracts are required to deposit with brokers.

Customer margin Within the futures industry, financial guarantees required of both buyers and sellers of futures contracts and sellers of options contracts to ensure fulfillment of contract obligations. Futures Commission Merchants are responsible for overseeing customer margin accounts. Margins are determined on the basis of market risk and contract value. Also referred to as performance bond margin.

Initial margin is the equity required to initiate a futures position. This is a type of performance bond. The maximum exposure is not limited to the amount of the initial margin, however the initial margin requirement is calculated based on the maximum estimated change in contract value within a trading day. Initial margin is set by the exchange.

If a position involves an exchange-traded product, the amount or percentage of initial margin is set by the exchange concerned.

In case of loss or if the value of the initial margin is being eroded, the broker will make a margin call in order to restore the amount of initial margin available. Often referred to as “variation margin”, margin called for this reason is usually done on a daily basis, however, in times of high volatility a broker can make a margin call or calls intra-day.

Calls for margin are usually expected to be paid and received on the same day. If not, the broker has the right to close sufficient positions to meet the amount called by way of margin. After the position is closed-out the client is liable for any resulting deficit in the client’s account.

Some U.S. exchanges also use the term “maintenance margin”, which in effect defines by how much the value of the initial margin can reduce before a margin call is made. However, most non-US brokers only use the term “initial margin” and “variation margin”.

The Initial Margin requirement is established by the Futures exchange, in contrast to other securities' Initial Margin (which is set by the Federal Reserve in the U.S. Markets).

A futures account is marked to market daily. If the margin drops below the margin maintenance requirement established by the exchange listing the futures, a margin call will be issued to bring the account back up to the required level.

Maintenance margin A set minimum margin per outstanding futures contract that a customer must maintain in his margin account.

Margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin at any particular time. The low margin requirements of futures results in substantial leverage of the investment. However, the exchanges require a minimum amount that varies depending on the contract and the trader. The broker may set the requirement higher, but may not set it lower. A trader, of course, can set it above that, if he does not want to be subject to margin calls.

Performance bond margin The amount of money deposited by both a buyer and seller of a futures contract or an options seller to ensure performance of the term of the contract. Margin in commodities is not a payment of equity or down payment on the commodity itself, but rather it is a security deposit.

Return on margin (ROM) is often used to judge performance because it represents the gain or loss compared to the exchange’s perceived risk as reflected in required margin. ROM may be calculated (realized return) / (initial margin). The Annualized ROM is equal to (ROM+1)(year/trade_duration)-1. For example if a trader earns 10% on margin in two months, that would be about 77% annualized.