Margin on futures can help establish a relatively large position, but it also adds certain risks
A certain amount of money, the maintenance margin, must always be maintained on deposit with a futures broker
When losses exceed maintenance margin, it may trigger a “margin call” at any time during the trading day
Levers and leverage, at the most fundamental level, are about doing more with less, or punching above your weight. Such principles apply to the futures market in the form of margin trading, which offers the potential to establish a position in a commodity—such as crude oil or corn—or some other asset with a relatively small amount of money. But with that leverage comes risks, including the margin call.
Much like margin trading in stocks, futures margin allows you to pay less than the full “notional” value of a trade, potentially offering more efficient use of capital or opportunities to hedge against adverse market swings. Futures margin is simply leverage that can enhance returns; however, it can also exacerbate losses, which is why it’s important to apply proper risk management.
There are a few different forms of margin, as well as important related concepts and terms: initial margin, maintenance margin, and the mechanics of a margin call, including the “intraday” margin call (more on that later). Here’s a quick rundown.
How Does Futures Margin Differ from Margin on Stocks?
Margin trading in the equity market means borrowing money from a broker to purchase stock—effectively, a loan from the brokerage firm. In the futures market, 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 (the cash equivalent value to owning the asset, or the total value of the contract). In equity margin trading, by contrast, an investor can borrow only 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).
What Is Maintenance Margin vs. Initial Margin in Futures?
A certain amount of money must always be maintained on deposit with a futures broker. Traders establishing a new futures position must 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 trader’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.
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 investors to post margin at higher levels than those specified by the exchange.
How Futures Margin Works: Crude Oil Example
Futures can be used to gain exposure to a specific asset class and speculate on price movement of individual futures products such as gold, crude oil, or equity benchmarks like the S&P 500 Index (SPX). For example, CME Group’s “Micro” futures contracts (based on oil), the SPX, and other markets are among the potential avenues for individuals to use margin without risking large amounts of money.
Micro WTI Crude Oil futures (/MCL) are one-tenth the size of CME’s standard WTI crude oil contract and represent 100 barrels of West Texas Intermediate grade crude, the U.S. benchmark. This means the Micro contract’s margin requirement is also one-tenth of its larger counterpart. As of August 2021, the maintenance margin requirement for one standard WTI crude oil futures contract was $5,100, and the margin requirement for a Micro crude contract was $510 (a little more than 7% of the contract’s notional value).
Say you expect crude oil prices to move higher, so you buy five Micro WTI contracts at $65 per barrel, putting up at least $2,550 in maintenance margin (plus initial margin) to control a position with a notional value of $32,500. If oil rises to $66, the notional value of the futures position would gain $500 ($1 x 100 barrels x 5 contracts) to $33,000. If you sold those five contracts at $66, you’d pocket a gain of $500.
But if the price of oil falls, this same leverage would work against you.
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What Happens in a Futures Margin Call?
Margin calls are triggered when the value of an account drops below the maintenance level, prompting the broker or FCM to require additional money to be deposited.
Using the aforementioned oil futures example, a drop in crude prices to, say, $64, would reduce the five contracts’ notional value by $500. If your account balance fell below the $2,550 maintenance margin, your broker would require you to deposit additional funds to bring your account back up to the initial margin requirement.
Futures trading is not for everyone, and as with 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. 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.
What Is an “Intraday” Margin Call?
There’s a perception that margin calls always happen after the trading day ends and markets are closed, but that’s not always the case. Under certain, often extreme, circumstances, a broker may require more funds from its clients while markets are still open—an intraday margin call. For example, earlier this year, JP Morgan was reported to have warned some hedge fund clients it may demand additional funds if positions lost value.
For TD Ameritrade clients, intraday margin calls may apply to certain day traders. Although margin calls are typically issued based on the market close, if a client’s positions are at risk of overexposure or extreme losses during the trading day, TD Ameritrade may try to contact clients to make them aware and potentially request additional funds if needed.
Finding Initial Margin on thinkorswim®
Initial margin requirements are easily accessible on the thinkorswim platform. To see initial margin, tick size, and other contract specs, follow the instructions in figure 1. In this example, an E-mini S&P 500 (/ES) futures contract has, as of August 2021, an initial margin requirement of $12,650. Be mindful that futures contract margin requirements vary for each product, and they can change at any time based on market conditions.
FIGURE 1: FUTURES MARGIN, CONTRACT SPECS. Qualified account owners can log in to the thinkorswim platform and see initial margin requirements and other contract specs. From the Trade tab, select the dropdown menu and then Futures. Chart source: The thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.
Qualifying TD Ameritrade account owners can apply online to trade futures products. To learn more about the application process, or about futures in general, please visit www.tdameritrade.com/futures.
Bruce Blythe is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.