Understanding Futures Margins

When viewing futures prices on charts, websites, newspapers, financial television, etc., the price quote is for one unit of that futures market. Similar to reading a stock price, that would represent one share. However, futures contracts trade in barrels, bushels, ounces, etc. For simplicity, futures traders will refer to these measurements as units. 

When crude oil (CL) trades at $101.34, this price reflects the price per barrel (one unit). However, the futures markets trade in standardized contract sizes. Instead of using $101.34 for one barrel, a trader would have to pay $101,340 to obtain 1,000 barrels. For crude oil, the standard contract is 1,000 barrels each (1,000 units). Multiplying the unit price ($101.34) by the total units in a contract (1,000) gives the contract's notional value of $101,340. 

Traders do not have to pay the notional value of crude oil to trade it. They will be required to post a margin that is much smaller in value. Currently, the margin for crude oil is $8,600 per contract traded. Using smaller amounts of capital to control the contract's notional value creates leverage. In this example, there would be about 12 times leverage. The notional value / margin = leverage. 

What is Margin? 

Futures margin is good faith money or collateral a trader deposits with their broker to assure the broker that any losses that may occur can be covered. These losses are transferred from the losing accounts to the winning accounts at the close of business each trading day. 

At the end of each trading day, all open positions are mark-to-market for accounting and risk management purposes. Mark-to-market allows funds to be available immediately after the close for disbursement, unlike the equity market, with a three-day settlement policy before funds are available. 

In the stock market, margin means something different than in the futures markets. When using margin in the futures markets, there are no fees associated with using margin. Using margin in the equity markets requires a trader to pay interest to the broker. 

To help distinguish between equity and futures margin, the futures industry tried to use the term performance bond in place of margin. For some reason, it never caught on, and you mostly see the word margin used. But, occasionally, you will see performance bonds used. 

Two Types of Margins

The two types of margins are day trade and overnight. 

Day trade margins are established by individual brokerage firms and often can be negotiated when opening a new account. Day trade margins only apply to the Regular Trading Hours (RTH). Once the RTH closes, the margin is increased to the overnight exchange minimum amount (covered under overnight margins).

Day trade margins are less than overnight margins, but not all brokerage firms offer day trade margins for all markets. Check with your broker to confirm they offer day trade margin for the market you wish to trade.

Lower margins while day trading result from less risk to the broker:

• RTH is the most liquid time of the trading session reducing slippage
• There is no gap risk coming into the trading session
• Most of the volatile economic reports come out before the RTH session starts

Overnight margins are determined by the exchange where the futures contract trades. These margins become the exchange minimum, and brokerage firms are not permitted to offer lower overnight margins. 

Due to the additional risk of holding positions overnight and over weekends, overnight margins are considerably higher than day trade margins. 

There are two types of overnight margins: Initial and Maintenance. 

The first night a trader holds a position, the exchange will require an initial margin. This amount is higher for the first night and then reduced for the second. The broker will remove this amount from your trading account and keep it until you close the trade. Any extra funds in your account after deducting the initial margin are yours to place other trades. The margin money cannot be used for anything other than the original trade.   

If a trader decides to hold a position for two or more nights, the exchange will remove the initial margin requirements and only ask for maintenance margin amounts. Therefore, reducing the amount of capital required to maintain the position. The difference between initial and maintenance margin amounts is 10% of the maintenance margin, increasing your buying power by this amount. 

Once the trade is closed, all of the maintenance margin is returned to your trading account, plus or minus any profits or losses (including commissions) you may have had. These funds are available immediately to trade with or withdraw from your account. 

How is Margin Calculated 

The amount of margin required to trade futures has nothing to do with what price the market is trading. 

In the equity market, if a trader buys 10 shares of a stock that is trading at $15, it would cost $150. If the trade goes to $25 and the trader sells all 10 shares, a profit of $100 would be realized. Let's assume the trader thinks the market might go higher and wants to re-enter the same stock. How much would it cost to buy 10 shares at this price? The answer would be $250, and an additional $100 capital would be required to re-enter the same stock trade at a higher price. 

In futures, the price the market trades at has absolutely nothing to do with the amount of margin required to trade that market. What determines margin is: risk and volatility. Exchanges review the volatility daily to determine if an adjustment is needed. While they check all markets daily for volatility and risk changes, the margin is changed infrequently. 

The chosen system for checking risk and volatility is the CMEGroup's "Standard Portfolio Analysis of Risk" (SPAN) to assess the markets. SPAN is used at all the major futures exchanges worldwide to help ensure that margin rates are relatively the same during trading in different time zones.

Exchanges will look at three different kinds of volatility to make their decision on margin rates:

• Historical Volatility – Price changes from one day's close to another
• Intraday Volatility – Price changes within a market session, regardless of whether there are price changes from close to close
• Implied Volatility – Forward-looking measure of potential volatility derived from the analysis in the Options markets
• Exchanges will also review other factors such as liquidity, seasonality, current and anticipated market conditions, and any additional relevant information they see fit for determining margin levels.

Margin levels are designed to cover approximately 99% (3 standard deviations) of the possible price moves for a position in a trading day or multiple trading days. 

During volatile periods in a market, a clearing member like the CMEGroup will generally raise the margin to account for the perceived risk. Some of the factors that could contribute to this volatility are:

• Supply/Demand shifts
• Changes in fiscal policy
• Major geopolitical events
• Natural disasters

When the daily volatility decreases, margins typically go down because the perceived risk is lower for traders holding open positions.

Margin Calls

After removing the margin, your buying power will be the remaining money in your account. As long as the buying power stays above zero, the margin requirements are adequate. However, if this trade or other trades you are in start to use up your buying power due to losses, this could result in the broker having to use your maintenance margin to cover your losses if the buying power goes negative. 

Your account will now be below the exchange minimum, and the broker will contact you with a margin call. Margin calls to clients are typically done in the afternoons. 

The broker will give you two choices:

1. Wire more money to your account to bring the balance back up to the initial margin.
2. The broker can liquidate your position on the next session open for you.

In most cases, the risk becomes enormous when a trader gets a margin call. The logical answer to your broker would be to let them liquidate the position. There is no reason to throw good money after bad by sending more money. 

Sources for Margin Amounts 

Your brokerage website will have both the day trade and overnight margins posted that they will require—the exchange website where your market trades will have the overnight margins posted. And Barchart.com has a contract specification page with margins posted as well.