Margins

Understanding the types of margin is essential to understanding of commodity futures trading.If previous investment experience has mainly been common stocks or securities then your familiar with the term margin, e.g. the cash down payment and money borrowed from a broker to purchase securities. But used in connection with futures trading, margin has an altogether different meaning and serves an altogether different purpose.

Rather than margin being a down payment, the margin required to buy or sell a futures contract is a deposit of good faith money, which can be drawn on by your brokerage firm to cover losses or to meet margin calls during futures trading. It is very much like money held in an escrow account. Minimum margin requirements for a particular futures contract at a particular time are set by the commodity exchange on which the contract is traded. Margins are typically about five percent of the current value of the commodity contract. Exchanges continuously monitor market conditions and, when necessary, raise or reduce their margin requirements. A Commodity broker may require higher margin amounts from their customers than the exchange-set minimums.

The two margin-related terms you should know are initial margin and maintenance margin.

Initial margin is the amount of money that the customer must deposit with the brokerage firm for each commodity 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. Conversely, on days losses accrue, money will be deducted from the margin account.

Maintenance margin is when funds available in your margin account are reduced by losses to below a certain level, typically when the position reaches seventy-five percent or below the initial requirement. At this point your broker will require that you deposit additional funds to bring the account back to the level of the initial margin. You may also be asked for additional maintenance margin if the exchange or your brokerage firm raises its margin requirements. These requests for additional margin are known as margin calls.

For example, assume that the initial margin required to buy or sell a particular commodity contract is $1,000 and that the maintenance margin requirement is $750. Should losses on open positions reduce the funds in your trading account $650, you would receive a margin call for the $350 needed to restore your account back to $1,000.

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 open positions at the available market price.

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