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As is apparent from the preceding discussion, the
arithmetic of leverage is the arithmetic of margins.
An understanding of margins--and of the several
different kinds of margin--is essential to an
understanding of futures trading.
If your previous investment experience has mainly
involved common stocks, you know that the term
margin--as used in connection with securities--has
to do with the cash down payment and money borrowed
from a broker to purchase stocks. But used in
connection with futures trading, margin has an
altogether different meaning and serves an
altogether different purpose.
Rather than providing a down payment, the margin required to
buy or sell a futures contract is solely a deposit of good
faith money that can be drawn on by your brokerage firm to
cover losses that you may incur in the course of futures
trading. It is much like money held in an escrow account.
Minimum margin requirements for a particular futures
contract at a particular time are set by the exchange on
which the contract is traded. They are typically about five
percent of the current value of the futures contract.
Exchanges continuously monitor market conditions and risks
and, as necessary, raise or reduce their margin
requirements. Individual brokerage firms may require higher
margin amounts from their customers than the exchange-set
minimums.
There are two margin-related terms you should know:
futures initial margin and maintenance margin.
Futures Initial Margin
Sometimes called original margin, is the sum of
money that the customer must deposit with the brokerage firm
for each futures contract to be bought or sold. On any day
that profits accrue on your open positions, the profits will
be added to the balance in your margin account. On any day
losses accrue, the losses will be deducted from the balance
in your margin account.
If and when the funds remaining available in your
margin account are reduced by losses to below a
certain level--known as the maintenance margin
requirement--your broker will require that you
deposit additional funds to bring the account back
to the level of the initial margin. Or, you may also
be asked for additional margin if the exchange or
your brokerage firm raises its margin requirements.
Requests for additional margin are known as margin
calls.
Assume, for example, that the initial margin
needed to buy or sell a particular futures contract
is $2,000 and that the maintenance margin
requirement is $1,500. Should losses on open
positions reduce the funds remaining in your trading
account to, say, $1,400 (an amount less than the
maintenance requirement), you will receive a margin
call for the $600 needed to restore your account to
$2,000.
Before trading in futures contracts, be sure you
understand the brokerage firm's Margin Agreement and
know how and when the firm expects margin calls to
be met. Some firms may require only that you mail a
personal check. Others may insist you wire transfer
funds from your bank or provide same-day or next-day
delivery of a certified or cashier's check. If
margin calls are not met in the prescribed time and
form, the firm can protect itself by liquidating
your open positions at the available market price
(possibly resulting in an unsecured loss for which
you would be liable).
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