Greetings traders and welcome back.
Thank you for joining me again.
My name is Chris, and I will be your host today as we have
another In Depth with Chris episode.
Today, we're going to be discussing futures margin.
We're going to talk about what futures margin is, as well
as compare it to securities margin, and then we're going to
outline all of the different types of margin out there, as
well as how to calculate it.
It'll be pretty in-depth so bear with me, and let's have
a good time together because we always do. I'll see you on the other side.
One of the most attractive features that the
futures market offers is the fact that it allows trading with leverage.
This just means that us as traders can commit to a relatively
small amount of capital, but still have the ability to make
large trades on an asset. The leverage is made possible
thanks to what is known as futures margin.
That is exactly what we're going to be covering here today;
Futures margin. So what is futures margin?
Well, it is simply the minimum amount of funds required in
your trading account to initiate a buy or sell futures position.
In short, that means it is the minimum amount of capital
that we need to execute one of our trades. The margin is usually
based on a fraction of a contract's total value.
The actual amount does vary from market to market, and it
also will sometimes differ if the trader is doing a day trade or holding
the position overnight, and we will get to that. Margin
allows for trading with high leverage, which is actually
a crucial instrument in the futures market. With leverage,
we don't need to put up 100% of the futures contract's value,
which can be quite expensive, when we're initiating the trade.
Instead, we can use our margin and enter a large position
with a relatively small amount of money.
We want to keep in mind that leverage is always going
to be considered a double edged sword because, while the gains
can be amplified well, so can the losses, and sometimes the
losses can be way heavier than our original margin amount
should the trade swing the other way and the position not be closed.
Let's just for a minute pretend that there's a guy right
over here, and his name is going to be Mr. Futures, and this is his weapon.
He's got really, really weirdly long arms and tiny legs.
Then we have a guy over here, and this is going to be Mr.
Securities Margin, and this is his weapon over here with, once
again, really long arms and really small legs.
Essentially, what we've got going on here between the two
of them, futures margin typically represents around
3-12% of the notional value of each futures contract,
whereas securities margin generally requires the traders
to put up somewhere around 50%, and it does change, but 50%
in the face of the value of the security being traded.
That's a huge difference.
We're talking about 3-12% to 50%.
In the stock market, margin refers to the money that we are
required to have in our accounts in order to borrow against the asset.
The amount that we borrow is kind of like a loan which allows us to access
greater sums of capital to buy and own stocks, bonds, and ETFs.
The loan allows us to leverage our positions.
This practice is also referred to as "buying on margin", and
it essentially amplifies
our trading results to gain bigger profits on successful trades.
In the futures market however, margin is the amount of money that we are required
to deposit and keep on hand with the broker when entering
a futures position. We want to keep in mind that it's not
the same as a down payment. Funding our futures trading account
with the required margin doesn't mean that we own the underlying
commodity being traded. We can think of it like a good faith
deposit, without which we won't be able to enter the trade in the first place.
Let's take a moment to talk about the different types of futures margin.
There are really two main categories;
We have initial margin, and then we have maintenance margin right here.
First, we'll talk about the initial margin.
The initial margin is just going to be the minimum amount
of money that is set by a futures exchange platform to enter a futures position.
It's really the exchange that will always specify the margin
amount, but the broker is allowed to, and will most likely
have some type of additional deposit or requirement that
we must add to our account before we can begin trading. That's very common as well.
We want to remember that initial margin is just the requirement by the exchange.
The very minimum is going to be just the exchange requirement
for us to open the position.
Then, we have our maintenance margin.
The maintenance margin refers to the amount of money
that we must maintain. So, maintenance and maintain. We must
maintain this amount of money in our account at any given
time in order to cover any potential losses.
Usually, your maintenance margin is going to be lower than your initial margin.
That is almost always the case, and we actually have
a graph here with a few different reports from the initial
margin and maintenance margin as of recently that we can
take a look at to see this type of behavior.
We have our initial margin column here,
and then we have our maintenance margin column here. In the initial margin column,
we can see that for the e-mini S&P 500,
the initial margin is 13,200. With the maintenance margin,
it's only 12,000 so it is a tad lower. Then with the micro e-mini S&P 500,
once again, this is the micro e-mini, it's only 1,320.
We just take a fraction of that, and bring her on down.
Then for the maintenance margin, same scenario, same ratio,
down to 1,200. Crude oil is going to be 6,160 with a maintenance
of 5,600. Gold is almost up there near those ten thousands,
but 9,185 with a maintenance of 8,350. Then our 10-year
treasury note is 2,035 with a maintenance margin of 1,850,
and that's just because, you know, T-notes are crazy and all that good stuff
so they always have some arbitrary numbers, but moving on.
In addition to the initial margin and the maintenance
margin, we also have what is usually referred to as "day trade
margin" and "overnight margin". With the day trade margin, this guy here,
this is basically referring to the amount of money that we
need for a full day's trade.
This means that it will be the minimum amount of money required
to day trade a contract. With day trade margin, we're basically
opening and closing our futures position within the same
trading session, and we're not carrying it forward to the
next day's trading. This margin is almost always going to
be set by our broker. As far as the overnight margin goes,
this is also referred to as "position trade margin" on on some
platforms. This is the margin that's required to hold
our position past the closing time of the market and into the next trading day.
This margin is also set by the exchange based on the futures
contract, market, and volatility.
It depends on what we're looking at, but that will be set by the exchange.
We have the overnight margin, and that's going to allow
us to hold our position through the closed off trading hours
and wait on until the next opening trading day.
Bum bum bum tss tss tss bum bum bum tss tss tss.
That's my terrible attempt at making a scary noise because
margin calls are every trader's worst fear.
That's what happens when the phone rings and it's our broker
saying we need to bring our account balance back up to our
maintenance margin requirement.
What this means, you know in real people terms, is that
if the funds that we have, if our account balance does drop
below the maintenance margin that we agreed to maintain, they
call us and say, "hey, you got to bring it right back".
If we don't, they actually have the ability, and will, close our position out.
Another option that we do have with a margin call scenario
is, we are also given the ability to reduce our position size
in such a way that it does fall into the maintenance
margin bracket criteria, whatever it is that we're trading.
If we were to just take an easy example of, say we deposited
15,000, so we'll say we deposited 15K to an arbitrary
broker and we opened, say two e-mini S&P 500 contracts.
So, we open two contracts.
Boom, open two. We're going to say that the initial margin
required for that was 6,600 per contract. That means 13,000, so it'd be 13.2K.
That'd be 13.2K as far as the initial margin that's required for two e-mini
S&P 500 contracts so we're within our right to do this. Let's say the maintenance
margin was 6,000 per contract,
so that means we would have a maintenance margin of 12,000,
so we got a maintenance margin of 12K.
12,000 is our maintenance margin.
Well, let's say that the trade is, you know, going alright,
and then all of a sudden some bad market volatility just
does not go in our favor and, boom, we lose like $3,500.
Well, what would $3,500 off of our, you know, if we
took that away, if we took 3.5K away from our 15,
we're going to be below this guy here.
We're going to be below the 12K. That means we are below our maintenance
margin, which means, guess what? This phone over here is going
to ring and the broker is going to say,
"hey, we need to go ahead and get your account back up to
at least $12,000 for this position", or you have the
ability to close off one of your e-mini S&P 500 contracts
because then your maintenance margin requirement would only
be 6,000, because we'd be cutting it right in half.
Long story short, a margin call is when we fall below our
maintenance margin and we are required to do whatever it
takes in order to make our account whole again with the
maintenance margin requirement.
Doesn't matter how we get there, but we need to get there,
and if we don't get there, the broker will close out our positions.
How are the futures margins calculated?
The futures margins themselves are governed by the exchange
through a calculation that is known as the "standard portfolio
analysis of risk", which from here on out, we're just going to call it SPAN.
I'm not saying "Spam" like that gross meat in a can, but SPAN.
That is, the SPAN margining system.
SPAN uses a complex algorithm to assess overall risk.
It's done by calculating the worst possible loss that a portfolio
might reasonably incur over a specified period of time,
which is usually one trading day.
It does this by computing the portfolio's potential gains
and losses under different market conditions. An example would
be, say the CME itself. They do use the SPAN system to determine its futures
margin. It utilizes the SPAN risk array methodology, which
is a heck of a mouthful to say, to assign a set of numeric
values, and those values indicate how particular futures contracts
will realize profit or loss under various conditions known
as, risk scenarios. Each of those risk scenarios takes into
consideration key factors including changes in the underlying
price of the index, current market volatility, and a decrease
in time to the contract's expiration. The SPAN margin utilizes
the value at risk, which is known sometimes as VAR. The
VAR, value at risk, statistical concept to determine the initial
margin. It's based on the premise that it should be adequate
enough to cover losses incurred in a position in 99% of the
cases based on historical data. Essentially, SPAN assesses
risk involved with each contract. The greater the risk, the
higher the initial margin requirement will be. Because the
CME is one of the most popular organizations for futures
contracts, many exchanges and other clearing organizations
tend to use the CME's SPAN parameters to compute their desired
degree of risk coverage.
These are some of the ones, once again, that the CME is
using, so it doesn't hurt to be familiar with them.
The first one is called the price scan ranges, which is also
referred to as the scan risk. This refers to the highest price
movement that is likely to occur for each instrument under
a specified time period. Then, we have the volatility scan
ranges. This is the highest level of change that is most
likely to occur with the underlying volatility affecting
each future options price.
Next, comes the intra-commodity spreading parameters.
It sounds like something from the future.
These are the rates and rules used to evaluate risks of closely
related products among portfolios.
Then, we have the inter-commodity spreading parameters, which
is the rates and rules used to evaluate risk offsets
between related products. Finally, we have delivery risk parameters,
which is the rates and rules used to evaluate the heightened
risk of futures positions that involve physically deliverable
products as the delivery period approaches.
There are some benefits of futures margin trading that we should definitely mention.
The first one is going to be hedge risk, and that's because
it can help us avoid a buildup of losses.
It helps us hedge risk because futures margin allows for
sufficient liquidity in a highly leveraged market since accounts
must be topped up to continue holding a losing position.
Then, we also have that it can protect us from a total wipeout,
which is somewhat similar to the hedge risk category. It can
protect us from a total wipeout in a losing position since the
exchange and the broker will require us to top up our account
whenever it reaches a certain level. Then a huge benefit
is the fact that there's no counterparty risk.
This is key. This eliminates all counterparty risk with
the process of the futures margin. With the futures margin
system, all futures contracts have sufficient equity for
settlement. This in turn provides a safe and reliable
futures trading environment for all parties involved.
Naturally, there is drawbacks of futures margin, but not
a whole lot. The prevailing drawback of the futures margin
system is that the losses incurred on each contract must
be settled on a daily basis.
Sometimes the underlying index can enter bearish territory
for days without any significant gain, but then make a sudden
turn around in one day and start posting some juicy profits.
This means that the traders may have to hold on their positions
throughout that period, which incurs additional equity injections
for overnight margins.
In conclusion, margin is one of those things that gets a bad rap, but not
really deserving of it. People associate it with negative
things just because of the margin call, which obviously no
one likes a margin call, but in reality, the overall help of margin
is something that generally is a net positive for us. In practice,
it is holding the market together and actually preventing
unnecessary losses on our own accounts, as well as an assurance
that all parties will meet their obligations. If you
think that you were able to grasp all of these concepts and
that your trading is there, make sure you check out the Gauntlet
Mini because I am seeing traders kill it, and I want to see
if you have what it takes as well.
In the meantime, thank you for joining me again everybody.
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keep hanging out with you, but until next time, over and out. Happy trading.