How futures work: Margins and margin callsHow futures work: Margins and margin calls

Class continues. Here’s a look at margins and margin calls, a bugaboo for many futures neophytes.

Nevil Speer

July 3, 2019

2 Min Read
How futures markets work: Margins
Nevil Speer

One of the most challenging aspects to understand around futures markets are the mechanics of margin and/or margin calls. As such, this week’s illustration highlights an example of margin calls during the past several months for parties on each side of November feeder cattle.   

Several starting assumptions are important here. First, assume the contract was entered into at $161 per cwt, making the total contract value of 50,000 pounds equivalent to $80,500. Second, let’s also assume the contract closed on June 24 at $133 per cwt with contract value of $66,500 – a net decline of $14,000 from the starting point. 

Here enters the aspect of margin; it represents a small portion of total contract value but represents a trader’s “skin in the game.” And as any seasoned trader will let you know; those margin calls can get very painful if you’re on the wrong side of the market.

Several key concepts are important to distinguish here: 

  • Initial margin: The initial amount of up-front money required to buy and/or sell a futures contract. For this example, initial margin was $3,100. This can vary from broker to broker depending on the contract and the customer. 

  • Maintenance margin: The minimum amount a trader’s account must carry tied to the contract position. This amount is established by the CME Group. Currently, the feeder cattle contract maintenance margin equals $2,800.  

  • Margin calls: When maintenance margin falls below the minimum threshold (in this example, $2,800), the margin call represents the amount of money required to reestablish the margin account back to the initial margin level.  

Related:How futures work: Position changes over time

Ok, let’s jump in the game. Assume you went long November feeder cattle on April 19, 2019 at $161. Since then, the market has worked against your position. Your purchase has lost $14,000 in total value – and you’ve subsequently received 13 margin calls in the total amount of $14,000 to keep you in the game.  

How futures markets work: Margins

Meanwhile, if you were short the contract, the market has moved in your favor. You’ve experienced only one margin call for a total of $462.50.  

At the end of this time period, margin accounts for the long and short trader would total $3,100 and $17,562.50, respectively. The long trader has deposited $14,000 in margin calls and has only $3,100 in his account. Meanwhile, the short trader has deposited the initial $3,100 plus one margin call of $462.50, which the market gave back over time. Hence, that short account is up the same amount the long account is down: $14,000.  

Therein lies the fundamental principle of futures trading: For every winner, there’s a loser and for every loser, there’s a winner—a perfect zero-sum game.  

Related:How futures work: Open interest, respective long and short positions

 

About the Author

Nevil Speer

Nevil Speer works as an industry consultant based in Bowling Green, Kentucky.   He has experience in both academia and private industry.  His career includes working with several start-ups along with various service and consultation projects spanning a wide variety of topics.  

Dr. Speer holds a PhD in Animal Sciences from Colorado State University and an MBA from Western Kentucky University.

You can contact him at [email protected] 

Subscribe to Our Newsletters
BEEF Magazine is the source for beef production, management and market news.

You May Also Like