A futures contract is a legal document for buying or selling a specific commodity asset/security at a specific future date and price. As futures trading is an obligation for fulfilling a future contract, it entails risk because of price volatility, even resulting in a loss. The volatile nature of the market necessitates the need to have a certain margin. A futures contract allows a trader to create an initial margin based on the total trade notional value. Let us then understand margins on futures contracts and their relevance to futures trading in India.
What is Futures?
You need to open a trading account to buy and sell securities, including derivatives. A reputed online broker also offers options trading apps, wherein you can do options and futures trading. Investors with good market acumen can make quick money in futures, as they get to trade with ten times more exposure than normal stocks. Also, price movements are higher in future markets than in cash or spot markets.
However, future trading comes at a charge. This derivative trading payoff for traders and investors is known as future contracts’ margins.
What are Margins on Futures Contract?
Margins or margin money is the amount of money kept as a deposit with your broker when you open a futures position. Without creating a margin, you cannot trade in the futures market. Margins cannot be considered down payment, and you are not the commodity owner. Margin money is an upfront payment that reduces the risk for the said exchange and helps maintain overall market integrity.
There are different types of margins. The margin level to be created by traders is decided by the exchange after considering volatility and volume. Margins are charged as a percentage of the total value of the futures contracts. They are usually a small percentage of the contract’s notional value, around 3% -12% per futures contract. This contrasts with the securities purchased on margin, which could add up to 50% of their face value.
Key Types of Margins on Futures Contracts
1. Initial Margin
The initial margin is calculated as a percentage of an open futures position. It differs for different positions, as decided by the exchange or brokerage firm. Initial margin values fluctuate daily as they depend on the stock’s average volatility for a certain period and interest cost.
2. Mark-to-Market Margin
This margin relates to the difference between the contract cost and closing price on the day you purchase the contract. On purchase, the mark-to-market margin implies the daily fluctuations in the closing prices.
3. Exposure Margin
To manage volatility and over-speculation, the exchange sets an exposure margin for the futures market. Exposure margin is charged on the contract value when you trade in futures.
4. Premium Margin
Premium Margin charged on a per-share basis relates to the amount given to the seller for writing contracts.
The margin on futures contracts helps traders participate in the futures markets and book profits by making a small upfront charge instead of the total contract amount.
