If you are planning to trade futures, one of the most important things you should know about is margin and how it is calculated. This post will help you understand the margin concept in detail.
To purchase or sell a futures contract in the stock market, you are required to pay a margin amount for initiating the trade and maintaining the position. The stock exchanges fix the margin requirements, and it is generally around 15%-20% of the actual value of the contract.
For instance, if you want to purchase 3,000 shares of SBIN in cash at the current price of Rs. 295, you will have to pay Rs. 885,000. But you can purchase a futures contract of SBIN, which has 3,000 shares in it, with a margin of about Rs. 175,000. So, in a way, futures trading allows you to buy or sell a higher number of shares at a considerably reduced capital.
But how do margins work? How to calculate it? Let us have a look-
- What is Futures Margin?
The stock market is volatile by nature, and you are required to pay a margin for every future contract for covering this volatility risk. For instance, as mentioned above, you can purchase a futures contract of SBIN with a margin of about Rs. 175,000.
If at all the price of SBIN starts falling after you purchase the futures contract, the losses incurred would be deducted from your margin money.
- Types of Futures Margin?
The margin you pay for a futures contract has 2 aspects to it- SPAN margin and exposure margin. The SPAN margin is calculated based on Value at Risk (VAR) statistical concept. It is also known as the initial margin and is calculated based on the maximum losses you could incur in a single trading day.
Exposure margin is also known as Market-To-Market (MTM) margin and is collected based on the daily volatility. So, while in the above example, the total margin required was Rs. 175,000, it had a SPAN margin of around Rs. 105,000 and exposure margin of about Rs. 70,000.
- What is Premium in Futures Margin?
The margin requirement for every futures contract is set by the stock exchange. However, a broker is free to ask for a higher margin for reducing their risk exposure. So, you will very commonly see that the margin of the futures contract is higher on volatile days like on Budget Day.
This is because the brokers expect a higher level of volatility on such days. For reducing their risk exposure, an additional premium is added to the margin amount.
- What is Margin Maintenance?
If your futures trade backfires or fails to work as expected, you will need additional funds in your trading account for maintaining the margin. The margin fluctuates on a daily basis based on the price of the futures contract.
A margin call will be triggered if you are unable to maintain the margin. Your broker will contact you through phone or email asking you to deposit additional funds for margin maintenance. If you fail to do so, the broker might also square-off your position.
- How to Calculate Margin?
Manual calculation of futures margin is very complex and time-consuming. A faster and accurate alternative is using a margin calculator. You can find one on the website of every reputed stockbroker.
With the calculator, you simply need to select the contract you’d like to trade, exchange, expiry, and number of lots to instantly know the total margin you will need for initiating the trade.
Understanding the Basics to Master Futures Trading
Margin is one of the fundamental concepts in futures trading. Understanding it thoroughly will definitely help you in your trading journey, allowing you to make confident trade decisions.
Before placing any buy/sell trade in futures, it is wise to use an online calculator to know the exact margin requirement. This will help you make sure that you have adequate funds for initiating a futures position.