Margins in futures and options trading
Margin, as used in futures trading, is a good faith deposit of cash. It assures the brokerage firm of one’s intention to purchase, sell or fulfill the obligation generated from selling options contract or buying futures contract. Minimum margin requirements represent a very small percentage of a contract’s total value, usually between 12-15%.
Margin in Futures Trading –
It only takes a small amount of money to purchase a futures contract. For under Rs. 20000/- a trader might be able to purchase a NIFTY Index contract worth Rs 2,50,000/- .
A brokerage firm sets the margin for its customers; the clearinghouse sets the margin requirements for brokerage firms. Clearing margin is deposited by a firm with its clearinghouse to assure that firm’s on behalf of its clients will be able to meet the obligation of clearing.
When a client opens a position, the margin deposited is called “initial margin“.
While futures exchanges set minimum margin levels, brokerage firms can, and often do, require a larger margin than the exchange minimum.
Based on the closing prices, your account is then debited or credited each day you maintain your position.
For example, assume you bought 10 NIFTY futures contracts at a price of Rs. 5145/- and posted initial margin. At the end of that trading day, the market closed at Rs. 5175/-. As a result, the market has moved in your favor by Rs 30/- , or a total amount equal to contract*lot size* P&L based on settlement price (in above case it is 10*50*30 = Rs 15000/-) . This amount will then be credited to your account and is available for withdrawal. Losses, on the other hand, will be debited from the account. This process is called marking-to-market.
Subsequent to posting initial margin, you must maintain a minimum margin level called maintenance margin. If debits from your market losses reduce your account below the maintenance level, you’ll be asked to deposit enough funds to bring your account back up to the initial margin level. This request for additional funds is known as a “margin call.” The maintenance margin varies with the commodity and exchange, but is generally 75% of the initial margin; thus, when the money on hand falls below the maintenance level, more money must be deposited.
Margin in Options Trading –
The treatment is slightly different for options. As options buyer have right to buy the stock/index as per the details of contract, hence they have no obligation to pay anything. In other words there is no risk involved in option buying. Worst case is that whole of option premium is lost. As a buyer, you just pay the full premium price*contract lot size to buy the contract and that’s it. No further margin requirements or daily mark to market adjustment.
As an option seller, the story is very different. I will explain this in next post with examples. So please followup for that. If you have any further doubt then please feel free to post them in comments section.