Futures Margins and Maintenance - Initial Margin and Maintenance Margin

Initial Margin and Maintenance Margin in the Futures Markets

Futures margin represents a performance bond, or a good faith deposit.  Futures margin represents a commitment by the futures trader that the financial obligations of the futures contract will be met.  Margins on futures contracts can, and do, change since margins are adjusted to risk.  If the futures contract goes through a period of sharp price increases, or decreases, the margin will increase to reflect the increased volatility of the futures contract. 

The exchange that the futures contract trades on can also increase or decrease the margin requirements.  This can happen if it is determined that there may be a period of increased or decreased volatility in the coming months.  Futures margins may be dropped back to normal levels after the event has passed, or futures margins can be increased if there appears to be a period of instability approaching.  Crude Oil is a good example of this.  During times of war, or political instability in the Middle East, the margin on the nearby contract will be quite high in respect to the further out months. 

The minimum margin levels for the initial margin and the maintenance margin are determined by the futures exchange that the futures contracts are traded on.  Futures brokers are allowed to set both margin rates higher than the minimum margin levels established by the futures exchange, but they are not allowed to set those margin levels below those minimums.  In most cases the futures brokers set their  futures margins requirements to those set by the exchange.

There are two levels of margin for futures contracts.  Initial margin (or original margin) and maintenance margin.  Initial margin is the amount the traders must have on deposit with their futures broker, or clearing firm, before they can place an order.  Maintenance margin is a set minimum amount, usually lower than the initial margin, that the trader must have in his / her account.  This is a threshold level and once the account balance drops below the maintenance margin level the trader will receive what is known as a margin call.  The trader must then deposit enough money to bring the account up to the higher, initial margin level, not the lower maintenance margin level.  Assuming that only one contract is being traded:

• Account Balance at the beginning of the trade $1750
• Initial Margin is $1500
• Maintenance Margin is $1000
• Open Position Loss is $790
• $1500 - $790 = $710
• Margin Call would be $710 that the trader would have to deposit into the account to bring the balance up to Initial Margin levels.

Initial margin as stated before is a good faith deposit and remains in the account.  The maintenance margin is a set level that the account cannot go below otherwise there is a margin call to bring the account back up to the initial margin level.  When the trade is closed, or offset, the margin funds are always returned to the futures traders account, adjusted for any losses greater than the amount on deposit in the account.  Using the above example, if the trade were closed instead of meeting the margin call, it would look like this:

• Account Balance $1750
• Open Position Loss is $790
• Maintenance Margin is $1000
• $1750 - $790 - $1000 = $40 Loss

Therefore, only $960 of the maintenance margin amount would be returned to the traders account, the $40 would be applied to the loss.

Margin Requirements for Speculators and Hedgers in the Futures Markets

There are two types of traders, the speculator, and the hedger.  Speculators take a long or short position in a futures contract hoping to profit from the price fluctuations of that futures contract.  Speculators are charged higher rates than hedgers. 

A hedger is an individual or a company that owns, or is planning to own a physical commodity.  A physical commodity would be Gold, Wheat, Soybeans, Corn, Currencies, Bonds, Cattle......  Hedgers are the producers and end users of the physical commodity and they need to lock in a price to protect themselves from price fluctuations in the market.  Hedgers do not usually pay the Initial Margin for their trades.  Most futures exchanges only charge hedgers the maintenance margin, and this amount is usually the same amount as the maintenance margin levels for speculative traders. 

Margin = Leverage.  High Profits or High Losses for Futures Traders.

Trading on margin can lead to spectacular profits, or terrifying losses.  Some people have made fortunes from trading futures, and others have taken their lives because of their losses in this business.  The margins set by the futures exchanges are only minimum rates.  Trading with just the minimum margin in your account is very poor money management and can easily lead to margin calls. 

While trading with minimum margin amounts will increase your leverage, and therefore increase your profits, it will also increase your losses just as quickly if the trade moves against your position.  Futures trading is all about risk management, and trading with more money in your account than the minimums required is the best way to trade futures.  Whenever possible stack the deck in your favor, the more money you trade with, the longer you will be in this business and a larger account balance gives you the opportunity to manage your money and limit your risk level.