Margin on futures provides leverage, which provides extra exposure
A certain amount of money must always be maintained on deposit with a futures broker, called the maintenance margin
When losses exceed maintenance margin, more money must be deposited or the position may be closed or liquidated
The lever is one of those ‘5 Simple Machines” you learned about in grade school, that are designed to allow people to do more with less. The lever’s power was evident as far back as ancient Greece, if not earlier. “Give me a place to stand, and I shall move the Earth with it,” Greek mathematician and inventor Archimedes once said, as legend has it.
Principles of leverage also apply to futures markets in the form of margin trading, which offers the potential to figuratively move mountains of commodities and financial instruments.
What is futures margin, and what is a margin call? Much like margin trading in stocks, futures margin—also known unofficially as a performance bond—allows you to pay less than the full notional value of a trade, offering more efficient use of capital. Futures margin is simply leverage that can enhance returns; however, it can also exacerbate losses, which is why it’s important to use proper risk management.
Here are a few basic questions and answers about futures margin: initial margin, maintentance margin, and the mechanics of a margin call.
How Does Futures Margin Differ from Margin on Stocks?
Margin trading in the equity markets means borrowing money from a broker to purchase stock—effectively, a loan from the brokerage firm.
In futures markets, an investor or trader puts down a good faith deposit called the initial margin requirement, or “performance bond,” as some exchanges call it. This ensures each party (buyer and seller) can meet their obligations as spelled out in the futures contract.
Initial margin requirements vary by futures product and are typically a small percentage—2% to 12%—of the notional value of the contract. (Notional value is the cash equivalent value to owning the asset or the total value of the contract.) In contrast, with equity margin trading, an investor can only borrow up to 50% of the purchase price or total value of the trade (based on the Federal Reserve’s Regulation T, or “Reg T,” rule).
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There’s Also Maintenance Margin in Futures—What Is That?
A certain amount of money must always be maintained on deposit with a futures broker. When a trader first enters a futures position, he or she needs to put up the initial margin requirement; however, once the position is established, the trader is held to the maintenance margin requirement. If the equity in a customer’s account drops below the maintenance margin requirement due to adverse price movement, the broker will issue a “margin call” to restore the customer’s equity to the initial margin requirement (more on that later).
An individual or retail investor who wants to trade futures must typically open an account with a futures commission merchant (FCM) and post the initial margin requirement, which, in turn, is held at the exchange’s clearinghouse.
Different futures exchanges specify initial margin and maintenance margin levels for each futures contract, but FCMs may require customers to post margin at higher levels than those specified by the exchange.
How Futures Margin Works
Futures can be used to gain exposure to a specific asset class and to speculate on price movement of individual futures products such as gold, crude oil, or the S&P 500 Index. Suppose you expect a price move upward in gold. For thinkorswim clients, as of June 2018, a gold futures (/GC) contract (specifying 100 ounces of gold) has an initial margin requirement of $3,410 (about 2.7% of the contract’s notional or total value).
If you had taken that same $3,400 and instead invested in physical gold, such as gold coins, you could buy a little less than three ounces, based on market levels in June 2018 (about $1,250 an ounce). But with a futures contract, you could gain exposure to the equivalent of 100 ounces of gold by purchasing—“going long,” in trading terms—a contract of /GC. And that’s what’s meant by “leverage.”
If you bought one contract of /GC at $1,250 an ounce, and the price were to rise to $1,260 an ounce, the futures position would gain $1,000 ($10 x 100 ounces), or about 29%, based on the initial margin requirement of $3,410.
But if the price were to go down, this same leverage would work against you.
What Happens in a Futures Margin Call?
As in stocks, margin can be a double edged sword. Because margin requirements for futures contracts involve leverage, profits and losses can be magnified, so it’s possible to lose more than the initial investment to open a futures position.
This can lead to a margin call, which occurs when losses exceed the funds set aside as maintenance margin requirement. When this happens, the broker or futures commission merchant (FCM) will require additional money to be deposited.
Using the futures margin example above, gold (/GC) had an initial margin requirement of $3,410, but the maintenance margin requirement is only $3,100. Usually the initial margin requirement is 1.1 times higher than the maintenance margin requirement. If you were long 1 contract of gold and gold fell $10 from $1250 to $1240, you would experience a loss of $1000. If your account started with an equity balance of $3410, your balance would drop to $2410. In this situation, your account equity balance is below the maintenance margin requirement of $3100 and you would be issued a margin call. This means you would need to fund your account with an additional $1000 to bring the account up to the initial margin requirement.
If a margin call is not met within a short time frame—often within a single business day—the position may be liquidated or closed.
Finding Initial Margin in the thinkorswim Platform
Initial margin requirements are easily accessible in the thinkorswim platform. To see initial margin, tick size, and other contract specs, follow the instructions in figure 1. In the example below, an E-mini S&P 500 (/ES) futures contract (which has a contract size of $50 times the S&P 500 Index), has, as of June 2018, an initial margin requirement of $6,160. Be mindful that futures contract margin requirements vary for each product, and they can change at any time based on market conditions.
And remember: Qualifying TD Ameritrade account holders can trade futures products by applying online through the TD Ameritrade website. To learn more about the application process, or about futures in general, please visit www.tdameritrade.com/futures.
FIGURE 1: FUTURES MARGIN, CONTRACT SPECS. Qualified account holders can log into the thinkorswim platform and see initial margin requirements and other contract specs. Under the Trade tab, click the dropdown box and click Futures. Image source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.