For many futures traders, the word margin carries a rather negative connotation. Flashbacks of short-notice bank wires or premature exits from winning trades often haunt practitioners of haphazard risk management. To some, it’s a nasty six-letter word, and margin call is the kiss of death.
Of course, the truth of futures margins is much less dramatic. That’s because it’s an integral part of applying leverage to the financial markets, as done in the trade of derivative products. Without margins, the range of opportunities available to commodity, currency, debt, and equity market participants would decrease exponentially.
The Bright Side of Futures Margins
Margin is the amount of money needed to control a futures contract. It’s a good-faith deposit made by the trader that ensures all associated parties are vested in the transaction.
In practice, there are three types of futures margins:
- Initial: Initial margin is the capital required by an exchange to assume the rights of a given contract. In futures, initial margin is typically in the neighborhood of 5-10% of total contract value.
- Maintenance: Maintenance margin is the amount of segregated capital needed to hold a contract through a daily or weekly close.
- Day: The day or day trade margin is the money required to open and hold an intrasession position in the market. Day trade margins are regularly much lower than initial or maintenance, due to the short-term nature of the allocation.
It’s important to remember that margins are subject to change. Individual products and current market conditions influence the requirements put forth by an exchange or brokerage. Typically, as volatility grows, so do futures margin requirements.
At first glance, the concept of margin appears to be just another worry for active traders. However, it serves an important purpose and offers several benefits to futures market participants:
- Purchasing power: Margin gives traders the ability to control large asset quantities while posting minimum capital. As an example, day traders are able to engage WTI crude oil for a modest $1000 per contract.
- Protection: The standardized futures trade falls under the regulatory authority of the U.S. Commodity Futures Trading Commission (CFTC). Among the duties of the CFTC is to ensure that exchanges and futures commission merchants (FCMs) have the financial ability to meet their obligations. This function effectively eliminates any assumption of counterparty credit risk by the trader.
- Responsible money management: Capital resources are an indispensable aspect of trade. As soon as they become overextended or exhausted, margin requirements help the trader to quickly recognize losses are mounting and strategic adjustments are necessary.
- Market liquidity: The availability of margin makes it possible for more people to engage the markets. By only requiring a fraction of contract value to be held on deposit, a trader or hedger does not need a six-figure account to trade.
In addition, staying on top of margin requirements has never been easier. Software trading platforms have made monitoring capital obligations routine. Automated alerts and open position/equity reports help active traders make sure that they’re never out of the loop in regards to futures margin.
Getting Started with Futures
If you’re going to trade futures, then margin will be an important factor influencing your venture into the marketplace. However, it’s nothing to fear. Futures margin requirements are designed to protect all parties involved. Ultimately, they work to promote and preserve the integrity of the trading environment.
For more information on margins, requirements, and the tenets of risk management, check out the resources department at Daniels Trading. From expert advice to contract specifications, Daniels Trading has everything you need to get started in the markets today.