Understanding Margin 

Margins are determined on the basis of market risk. Because margins are adjusted to risk, they help to assure the financial soundness of futures exchanges and provide valuable price protection for hedgers with a minimum tie-up of capital. Margins are typically set at 4 to 18 percent of the value of the commodity underlying the futures contract and assessed each day depending upon the settlement of the underlying futures market in a process known as Marked to Market.

The exchange has set two types of Margin Requirements: 

• Initial Margin Requirement is the amount of money a party must have on account with a clearing firm (your broker) at the time the order is placed. Initial margin funds must be on deposit before any trade can be accepted. 

• Maintenance Margin is a set minimum margin (per outstanding futures contract) that a party to a futures contract must maintain in his/her margin account to hold a futures position.

For example, assume that the current margin on a Soybean contract is $1,148 Initial and $850 Maintenance.  A trader would need to have at least $1,148 per futures contract in his/her account in order to initiate a futures position.  Once the initial margin requirement is met, the trader must maintain an account balance of $850 in order to continue to hold the position.

Assume for a moment that a trader has a $5,000 account and wishes to buy 3 November Soybean contracts.  Since the trader's account is greater than initial margin requirement (3 contracts x $1,148, or $3,444), he/she can initiate the position.  The $3,444 in initial margin is NOT removed from the traders account, but it is applied towards the maintenance margin.  At all times the trader is in this position, the account balance - reflecting open position profits and losses - must stay above the Maintenance Margin Require (or 3 contracts x $850 = $2,550).

Assuming that the trader bought 3 contracts at $7.00/bushel, the trader has $0.17 per bushel in excess margin.  For example, if Soybeans were to drop from $7.00/bushel to $6.83/bushel, the trader would have an open position loss of -$2,550 before commissions and fees, and an account balance of $2,550.  Since the difference between the maintenance margin requirement of $2,550 and the account balance of $2,550 is nothing, the trader would be on a MARGIN CALL.

When faced with a margin call, the trader has two options.  The trader can either liquidate the position - taking the loss - or deposit sufficient funds to bring the account balance back above the Initial Margin Requirement.

When faced with a margin call, traders usually have 24 hours to meet the call by wiring money into their account.  Common Sense Capital and/ or Man Financial has the right to liquidate the position at any time a margin call is made, and margin requirements are subject to change without notice, and traders must always meet margin requirements in a prompt fashion.

The best way to avoid margin calls is to be sufficiently capitalized.  Do not over trade, and remember that it is possible to loose more than account balance.

On the other hand, if the trader who bought 3 contracts at $7.00/bushel saw Soybeans increase from $7.00/bushel to $7.17/bushel, the trader would have an open position profit of +$2,550 before commissions and fees, and an account balance of $7,550, and an excess account balance of $5,000 due to the open position profits.  The trader is free to withdraw these funds, or to use these excess funds to add to a position.

Margin is what gives futures the tremendous leverage.  Leverage is a two edged sword, and can be a wonderful thing when the markets are moving in your direction, however leverage also increases losses when they are not.  Traders should always respect the markets and remember not to risk too much at one time as futures trading involves substantial risk.