Margins – Stocks Vs. Futures

A very common misunderstanding among investors new to futures trading is the term “margin” and what exactly it means. Let’s start with the definition of margin as it applies to the stock or equity markets. ‘Margin’ is a term used to describe when money is borrowed to buy a stock or security. Basically, ‘Margin’ is a loan normally provided by a stockbroker to his client to enable him to purchase additional shares with the loan of additional funds.

The term ‘Margin’ is also present in the commodity futures and options market, but it has a completely different meaning compared to the meaning of the stock markets.

When trading commodity futures, the term ‘Margin’ is the amount of funds an investor must have available in their account to open a position in a particular market. ‘Margin’ in commodity futures trading can be thought of as a “Yield Bonus”. The “Margin” funds available in a client’s account act as a “good faith” deposit in exchange for establishing a position in a given market. For example, if an investor wishes to establish a position in the Corn market, he/she would need to have $1,485* in available funds in his/her account to take a long or short position for a contract. Again, this ‘Margin’ amount is not deducted. The futures trading account now acts as a deposit that allows the futures trader to take a position in the corn market.

Margin is determined by the futures market you wish to trade. The original amount of money that the exchange requires you to deposit is called the initial margin. Initial margin can also be thought of as “day one” margin, as it is the amount of margin required when the futures position is originally established. This amount typically ranges from 5-10% of the total contract value and is subject to change from time to time based on current market conditions.

Along with the initial margin required by the futures market, there is also a maintenance margin for your account. Maintenance Margin is a lower dollar amount than Initial Margin and comes into play from the second day of an established future position. Essentially, futures trading will require a higher deposit to establish a futures position through Initial Margin. Once a futures position has been established, the exchange reduces the deposit amount (approximately 20%) down to the Maintenance Margin to give the trade “room to fluctuate”.

If the market moves against your established position and your account equity falls below the maintenance margin, you will receive a margin call. A margin call is a request from your broker to fund your account to return the value of the account to the original initial margin amount or to liquidate the open futures position. Most futures brokers require margin calls to be honored immediately. If a margin call is not satisfied, the futures broker has the right to liquidate any open position to satisfy the margin shortfall.

Most futures traders will not want to take delivery of the contract they are trading, so they will liquidate the contract before its expiration date. When a contract in which you own the rights is liquidated, your margin deposit is liquidated. Depending on the result of the trade, losses are subtracted or profits are added to your futures trading account.

* Based on exchange margin rates in effect as of December 16, 2009. Margins are subject to change without notice.

THERE IS A SUBSTANTIAL RISK OF LOSS INVOLVED IN FUTURES TRADING AND IT IS NOT SUITABLE FOR ALL INVESTORS.