Since the subject comes up quite often in regards to trading futures and commodities, Bernard Stegmueller, of Fusion Trading Zone, breaks down the ins and outs of futures margin, the amount of money a trader has to put up to control a futures contract.
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You will hear about futures margin quite often when trading futures and commodities. In a nutshell, futures margin is the amount of money you have to put up to control a futures contract.
Futures Margin is set by the Futures Exchanges and some brokerages will add an extra premium to the exchange minimum rate in order to lower their risk exposure. Margin is set based on risk.
The Larger Dollar
If you are familiar with trading stocks on margin, this might be easier to pick up. You can trade stocks on up to 50% margin. So, you can buy up to $100,000 worth of stock for $50,000. With Futures Contracts, it works in a similar fashion but the margin rate is much lower. Normally, you only put up about 5-15% of the contract value in margin. For example, if you want to buy a contract of wheat futures, the margin is about $1,700. The total contract is worth about $32,500 ($6.50 x 5,000 bushels). Thus, the futures margin is about 5% of the contract value.
Initial Futures Margin is the amount of money that is required to open a buy or sell position on a futures contract. Margin Maintenance is the amount of money where a loss on your futures position requires you to allocate more funds to bring the margin back to the initial margin level.
For example, suppose the margin on a corn futures contract is $1,000 and the maintenance margin is $700. If you buy a corn futures contract you will need to have $1,000 set aside for the initial margin. If the price of corn drops 7 cents, or $350, you have violated the maintenance level and need to add an additional $350 in margin to bring it back to the initial maintenance level.
Margin Calls: a margin call on futures contracts is triggered when the value of your account drops below the maintenance level. For example, you hold five futures contracts that have an initial margin of $10,000 and a maintenance margin of $7,000. The value of your account falls to $6,500. You will get a margin call requiring you to add $3,500 to your account to bring it back to the initial margin. You also have the option of closing your positions to eliminate the margin call.
How to Calculate Futures Margin
Futures margin rates are typically calculated using a program called SPAN. This program measures many variables to come up with a final figure for initial and maintenance margin in each futures market. The main variable is based on the volatility of each futures market. The exchanges do adjust their margin requirements occasionally based on market conditions.
By Bernard Stegmueller of Fusion Trading Zone
