About Margin Trading (cont.)

Initial Margin

 

The initial margin is the amount of money that needs to be deposited when opening a new futures position. Initial margin relates to future trading and does not differ if the traders’ goes long or short a futures position. Moreover, the calculation of the initial margin is based on a percentage of the total value covered by the futures contracts.

 

The percentage of total value covered differs based on the futures market that the investor is trading in. In terms of stock futures the initial margin needed is 20% of the value of the contract and for index futures and commodities futures, a calculation system is required. This calculation system is called ‘SPAN Margin’.

 

For example, let’s suppose a trader buys a futures contract for ‘X’ stock trading at $30 for 200 shares.

 

Total value covered: $30 x 200 = $6.000

Initial margin required: $6.000 x 20% = $1.200

 

 

Now, let’s assume that the first trading day has come to an end and the price of the ‘X’ stock rises to $30.10.

 

Total Profit: ($30.10-$30) x $6.000= $0.10 x 6.000= $600

Margin Balance: $1.200 + $600= $1.800

 

 

As can be observed above, the leverage effect of futures trading made a profit on the invested capital, just by a small $0.10 gain on the stock. Conversely, leverage cuts also if the stock drops. Suppose that the end of the second trading day the price of the ‘X’ stock drops to $29.90.

 

Total loss: ($30.10 - $29.90) x $6.000= $0.20 x 6.000 = $1.200

Margin Balance: $1.800 - $1.200 = $600

 

 

Here, the losses generated are taken out of the traders margin balance.

 

 

Maintenance Margin

 

The maintenance margin is the minimum sum of margin balance that traders need to have in their account in order to keep their futures position valid. In addition, the maintenance margin requirements would differ depending to the specific market that the trader trades in. when the margin level drops under the maintenance margin level the trader will receive a ‘Margin Call’ from the broker.

 

 

Margin Call

 

A margin call is an alert from the trader’s broker, notifying that there is a need to deposit money in his/her account when their margin level for the futures position dropped under the maintenance margin level. The additional sum of money needed to bring the margin level back to the initial margin is called ‘Variation Margin’.

 

The variation margin indicates that the trader will receive a Margin Call from the broker to deposit the necessary margin in the account in order to bring the margin level back to the initial margin.