Differentiate between margin in the securities markets and margin in the futures markets, and explain the role of initial margin, maintenance margin, variation margin, and settlement in futures trading.
The first deposit is called the initial margin. Initial margin must be posted before any trading takes place.
If the margin balance in the trader's account falls below the maintenance margin, the trader will get a margin call and must deposit the variation margin into the account to bring the margin balance back up to the initial margin level.
Which of the following statements regarding margin in futures accounts is FALSE?
A. Margin is usually 10% of the contract value for futures contracts.
B. With futures margin, there is no loan of funds.
C. Margin must be deposited before a trade can be made.
The answer is A. The margin percentage is typically low as a percentage of the value of the underlying asset and varies among contracts on different assets based on their price volatility. The other statements are true.
If the margin balance increases above the initial margin amount, the investor can withdraw funds from the account in the amount of the excess above the initial margin requirement.
The settlement price is an average of the prices of the trades during the last period of trading, called the closing period, which is set by the exchange. The settlement price is used to make margin calculations at the end of each trading day.
It is April 15, and a trader has entered into a short position in two soybean meal futures contracts. The contracts expire on August 15, and call for the delivery of 100 tons of soybean meal each. Further, because this is a futures position, it requires the posting of a \$3,000 initial margin and a \$1,500 maintenance margin per contract. For simplicity, however, assume that the account is marked to market on a monthly basis. Assume the following represent the contract delivery prices (in dollars per ton) that prevail on each settlement date:
April 15 (initiation) 173.00
May 15 179.75
June 15 189.00
July 15 182.50
August 15 (delivery) 174.25
What is the equity value of the margin account on the May 15 settlement date, including any additional equity that is required to meet a margin call?
Use the following steps to calculate the margin account balance as of May 15.
At initiation: (Beginning Balance, April 15)
Initial margin × number of contracts = 3,000 × 2 = 6,000
Maintenance margin × number of contracts = 1,500 × 2 = 3,000
As of May 15: (Ending contract price per ton<!-- Why is this ? here? --> ? beginning contract price per ton ) × tons per contract × # contracts = (179.75 - 173.00) × 100 × 2 = 1,350
Since the trader is short, this amount is subtracted from the beginning margin balance, or 6,000 - 1,350 = 4,650
Based on the May 15 settlement date, which of the following is most accurate?
A. Since the equity value of the margin account is above the initial margin, the trader can withdraw $1,350.
B. No margin call or disbursement occurs.
C. Since the equity value of the margin account is below the maintenance margin, a variation margin is called to restore the equity value of the account to its initial level.
As of May 15, the margin balance is \$4,650 (see solution to previous question). Since this is below the initial margin of \$6,000 (both contracts), but still above the maintenance margin of \$3,000, (for both contracts) no action is required.
There are three types of margin. The first deposit is called the initial margin. Initial margin must be posted before any trading takes place. Initial margin is fairly low and equals about one day’s maximum price fluctuation. The margin requirement is low because at the end of every day there is a daily settlement process called marking-the-account-to-market. In marking-to-market, any losses for the day are removed from the trader’s account and any gains are added to the trader’s account. If the margin balance in the trader’s account falls below a certain level (called the maintenance margin), the trader will get a margin call and have to deposit more money (called the variation margin) into the account to bring the account back up to the initial margin level.
Describe price limits and the process of marking to market, and calculate and interpret the margin balance, given the previous day’s balance and the change in the futures price.
Limits and the Process of Marking to Markets
Price limits change from the previous day’s settlement price.
Limit move: (If traders wish to trade at prices outside these limits, no trades will take place. The settlement price will be reported upper or lower price limits).
Locked limit: if trades cannot take place because of a limit move, either up or down, the price is said to be locked limit, since no trades can take place and traders are “locked” into their existing positions.
The margin requirement of a future contract is low because at the end of every day there is a daily settlement process called marking to market.
Which of the following statements regarding the mark to market of a futures account is least accurate? Marking to market of a futures account:
A. may result in a margin balance above the initial margin amount.
B. may be done more often than daily.
C. is only done when the settlement price is below the maintenance price.
Futures accounts are marked to market daily based on the new settlement price, which can result in either an addition to or subtraction from the previous margin balance. Under extraordinary circumstances (volatility) the mark to market can be required more frequently. Once the margin is marked to market, the contract is effectively a futures contract at the new settlement price.