Understanding a Margin Call in Futures Trading

 Understanding a Margin call in Futures Trading

A margin call is when a brokerage company demands that a client brings margin deposits up to their initial or original margin levels in order for them to keep their current position. A margin call is most commonly when the client's position is adversely affected, leading to a substantial drop in account value.

Margin acts as the good-faith deposit that keeps trades running smoothly on the exchange. This is the money that the client must have in reserve in order to guarantee the firm and any outside parties that it will be able to cover any debt it incurs through trades or if the market falls. What Happens after a Margin call?

Your broker may issue a margin call if one or more of your holdings falls below the maintenance level. This is a way to make sure that the client deposits more money into their account in order to continue holding a position. (You can also sell some of your holdings in order to bring the fund status back within the margin. This is not an option that is common.

The broker can liquidate any or all positions in your account to stop the margin calls if they fail to receive your funds within the agreed timeframe. This is known as a "forced sales" and brokers are entitled to this right in order to protect their accounts and avoid any major losses or profits from leveraging borrowed funds.

Initial vs. Maintenance Margin

Regulation T was established by the Federal Reserve Board. It sets two limits for futures trading margins: the initial margin, and the maintenance margin. The initial margin is the minimum amount of cash you have to reserve to purchase futures stakes. The rule requires that at least 50% of the sale price be cushioned.2 Brokers and other firms have the right to set their own limits. You may find brokers requiring closer to 70%.

You will have to pay between 50%- 70% of the future's price with your cash and the broker will take the rest through margin. The maintenance margin is the amount of cash that you will need to maintain your position after your initial purchase. This is the amount cash (or assets near cash) that you should keep in your account.

Regulation T requires that you maintain a maintenance margin of at minimum 25%. However, many firms place it closer to 30%-40%.

Example Margin Call in action

Imagine that you are trading a futures gold contract with a $5,000 initial margin. You deposit $6,000 into your commodity trading account. The maintenance margin on gold was at $4,000. The account value drops by $3,500 if the gold price moves against you $2,500. This drops below the $4,000 maintenance level by $500.

The firm will then issue a margin request to ask you to add $1,500 to your account to increase it to the initial margin of $5,000. The broker will end the margin call if funds fail to arrive in a timely manner.

You have several options for moving funds into your account in order to meet a margin request, but most people opt to wire transfer the money to the firm.

Traders Can Lose a Fortune

Margin can be described as a loan, or deposit of good faith, that allows traders to take on long or short positions in futures contracts. For most traders, margin is not sufficient to protect trades. This is not the end of your duty. If you buy or sell futures, your responsibility extends beyond the margin upfront to the total contract value, as well as the price of the market movements.

Commodities are considered risky assets. They have greater volatility than stocks, bonds, and currencies, and they also have less liquidity. It is not unusual for the price of a commodity in a short period to increase, decrease, or even disappear completely.

Futures traders must always be prepared for a margin calls when trading them. FCMs require futures traders to have enough funds in their futures accounts for any margin calls. Do You Know the Right Time to Move Out Against a Margining Dealer?