Do you need the futures margin explained? Margin is something many new traders don’t understand at first. Even some seasoned traders don’t get it. Margin trading allows you to use leverage to purchase futures with a value greater than your available funds. It’s like a credit card; you guarantee you will pay off your balance.
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Futures Margin Explained
When we enter the world of futures trading, a concept that can bring fear or joy into the heart of any trader is “margin trading.” This term can bring so much fear because there’s a lot of downside risk when trading on margin. Many inexperienced traders have made a few bad margin trades and been wiped out. With this article, we wish to teach you to be an informed margin trader. So you don’t make the big mistakes that are so feared. Margin trading can provide big profits quickly, which is their draw and benefit.
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You are charged interest on your margin balance; this can be as low as about 0.75%. The exchange is always on the opposite side of our trades, which means anonymity to the market.
Because the exchange is regulated by the Commodities Futures Trading Commission (CFTC), it must have the ability to meet all obligations to pay you, eliminating any credit risk.
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Initial Futures Margin
You start with a margin account minimally funded to an “initial margin.” Which is like a down payment for a trade and is a regulated percentage of total funds that can be traded.
With futures contracts, the exchanges set this initial margin to as low as 5% or 10% of the traded contract. For example, a wheat future is quoted at $6.362 for 5000 busses = $ 31,825; with a 5% margin requirement, you can enter a long position for 5% of this, or $1591.25. With the 5% margin requirement, you have 20 times leverage, which means your gains and losses are amplified by 20 times. If the price of a bushel goes up by only 10 cents and you close your position, you have a profit of $485(6.462*5000=$32310 minus $31,825).
This is about a 30.5% return on your $1591.25 (less your margin interest and trading fees, which would still be about $225, a 16% return).
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Maintenance and Futures Margin Calls
When you are down with your margin trading, you must deal with maintenance and margin calls. Maintenance is the money required when a position is down.
And you must add funds to the account to bring it up to the initial margin. For example, our trader has a margin account of $9000 and purchases a gold future 100oz at $2000/oz with an initial margin of $8250 and a maintenance margin of $7500.
Gold lost $8 per oz to $1992oz, and the total account balance dropped $8200. Our trader has no issues if the account’s value stays above the $ 7,500 maintenance margin.
But if the gold price continues to drop and goes below the $7500 mark, she will be required to add enough money to get the account back up to the $8250 initial margin. Which is referred to as a “margin call.”
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SPAN
Each exchange has a limited margin rate they allow traders to use for each future. This rate is determined using the SPAN(Standard Portfolio Analysis of Risk) program.
Several variables go into the SPAN program. But the recent daily volatility of the future is their most important.
This predetermined amount of margin required allows an exchange to know its “worst-case” scenario, a one-day move that might occur for any open futures position (either long or short).
This SPAN requirement can change anytime, and exchanges will alter these requirements depending on market conditions.
The SPAN margin limits are the highest leverage allowed. However, FCMs (Futures Commission Merchants) or brokerages can require higher margins (if the SPAN is ten times leverage, the FCM may allow five times, but never 20 times) of their customers.
This can be due to the risk classification of the customer or their ability to be contacted and lower their risk exposure.
Final Thoughts: Futures Margin
Because the margin is such a small part of the total value being traded, leverage allows futures traders to make or lose profits very quickly.
CFTC regulations protect profits. As a result, you don’t have to worry about the payment. We recommend not putting more than 10% of your portfolio at risk with any single trade.
The more trades you make and the greater your portfolio value, the lower this recommendation percentage is. Diversification is always needed to reduce any portfolio’s risk. Never trade on gut instinct; only make a trade with a reason behind it. As always, we wish you the best of luck with your trades.
