Active traders buy and sell futures contracts on the open market using a device known as margin. Margin is a good-faith deposit, or down payment, on the assumed liability of a newly opened position.
Margin requirements are specific guidelines established by exchanges and brokerage firms that must be met by each trader. They are product-specific and subject to change according to prevailing market conditions. If you are going to trade futures, having an understanding of how margins work is essential.
Futures Margin Requirements
For all intents and purposes, margin is the key facilitator of trade on the futures markets. Every contract that is bought or sold is done so using financial leverage: The trader is only required to put up a small amount of capital to open and maintain a new position. This capital is known as the margin.
In the arena of short-term trading, there are two primary types of futures margin requirements to be aware of:
Initial: Initial margin is the amount of capital necessary to open and hold a position through the market’s daily electronic close. At the end of each trading session, outstanding contracts are settled by the exchange clearinghouse. If a trader holds an open position into the close, the initial margin requirements must be met in order for the position to remain open. If not, it’s liquidated.
Day: A day margin is the minimum necessary to buy or sell a contract on an intrasession basis. They are defined by the brokerage and put in place to limit the liability of both the trader and broker. Day margins vary according to broker, market, and ongoing levels of volatility.
The important aspect of margin to remember is that it’s simply a safety device. Futures margin requirements protect the trader from catastrophic loss. In the event of an unexpected drawdown, open positions are liquidated in accordance with predefined margin requirements.
How to Avoid a Margin Call
In the modern futures market, a margin call consists of having an open position closed involuntarily. This may occur for any number of reasons, but is mostly due to an unexpected loss incurred on an open position. If a trade goes negative and margin requirements are not able to be satisfied, then the position is liquidated at market.
Avoiding a margin call is relatively simple. All a trader needs to be aware of is the relationship between the initial and day requirements. Take the following trade in gold futures (GC) as an example:
|Initial margin (GC)||$3,850|
|Day margin (GC)||$1,500|
An aggressive day trader is extremely bullish on the gold market and decides to buy 5 contracts at market price. Due to the time horizon, day margin requirements are critical to the trade and must be satisfied. Given the position size, here are the margin requirements of the trade:
- 5 contracts × $1,500 = $7,500
At least $7500 must be kept in the trading account in order for the long position to remain open. If the trade turns sour and losses reduce the account balance to less than $7500, a margin call will be issued. The broker will contact the trader requesting that additional capital be deposited to the trading account to cover the outstanding liability. If the trader is holding open positions in other markets, they may be liquidated to service the necessary margin.
Let’s say that the day trader becomes interested in holding the gold position through the CME electronic close. In order achieve this goal, the initial margin requirements must be met. This may be accomplished through either reducing position size or having enough on deposit in the account to cover the $3850 per contract allocation.
Many traders new to the market view futures margin requirements in a negative light. In practice, margins are safeguards from the unfavorable impacts of volatility and haphazard risk management.
If you’re confused about margin and leverage, consulting an industry professional may help. For more information, check out the brokerage service suite and expertise available from the team at Daniels Trading.