When we talk about securities margin and futures margin, we are talking about two very different things. Understanding the difference is important.
In the securities world, margin is the money you borrow as a partial down payment, up to 50% of the purchase price, to buy and own a stock, bond or ETF. This practice is often referred to as buying on margin.
In futures markets, margin is the amount of money that you must deposit and keep on hand with your broker when you open a futures position. It is not a down payment and you do not own the underlying commodity.
The good news is that futures margin generally represents a smaller percentage of the notional value of the contract, typically 3-12% per futures contract as opposed to up to 50% of the face value of securities purchased on margin.
Margin requirements may fluctuate based on market conditions. When markets are changing rapidly and daily price moves become more volatile clearinghouse margin methodology may result in higher margin requirements to account for increased risk. In contrast, when market conditions and the margin methodology warrant, margin requirements may be reduced.
Types of Margin
There are two main kinds of margin in the futures markets: initial margin and maintenance margin.
Initial margin is the amount required by the exchange to initiate a futures position. While the exchange sets the margin amount, your broker may be required to collect additional funds for deposit.
Maintenance margin is the minimum amount that must be maintained at any given time in your account. If the funds in your account drop below this level, you may receive a margin call requiring you to add funds immediately to bring the account back up to the initial margin level.
If you do not or cannot meet the margin call, you may be able to reduce your position in accordance with the amount of funds remaining in your account, or your position may be liquidated automatically once it drops below the maintenance margin level.
A small change in a futures price can translate into a huge gain or loss, so understanding how futures margin works is essential to maximize the capital efficiencies that futures afford.
Peter Knight Advisor