Types of Margins

Transactions in commodity futures are margin-based transactions. In other words, the trader of a futures contract is only required to put up a fraction of the total value of the specified commodity traded. Margin money is essentially a guarantee that the person (trader) will honor the contract entered into. Margin is set based on risk. Margin is a minimum amount of commodity that must be held in order to trade a particular commodity. It is required to minimize the risk of exchanges.

Now a question arises which type of margin is charged for transaction in commodity future. Four type of margin is charged in commodity future transactions. These are as follows:
· Initial Margin
· Mark –to-Mark Margin
· Special Margin
· Maintenance Margin

Initial Margin
Initial margin is the amount of money that is required to initiate a new position (enter a trade) on a futures contract. Investors have to pay margin to broker for initiating the position in futures, commonly used in trading futures and contracts for difference. Initial margin is usually set at a percentage of the value of the contracts being traded.

The minimum amount of the initial margin is set by the exchange and varies depending on the commodity, the commodity’s contract value, and how much and how quickly prices move up and down. The actual initial margins for most traders are set by futures commission merchants and are often higher than the minimums set by the exchange. e.g. If an investor wants to trade in gold and the price of 10 gm gold is 12000. The one lot size of gold is 1 kg. Before trading one lot of gold, investor should invest an initial margin that is Rs. 60000. (12000*100 = 1200000 @ 5 %).

Mark-to-Mark Margins:
Mark-to-market margins are payable based on closing prices at the end of each trading day. These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is worked out on difference between the closing/clearing rate and the rate of the contract executed (if it is entered into on that day) or the previous day’s clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.

Collecting mark-to-market margin on a daily basis reduces the possibility of accumulation of loss, particularly when futures price moves only in one direction. Hence the risk of default is reduced.

Special Margin
To curb the volatility a special margin is charged. In case of additional volatility, a special margin at such other percentage, as deemed fit by the Regulator/Exchange, may be imposed on either the buy or the sell side in respect of all outstanding positions. Removal of such Margins will be at the discretion of the Regulator/Exchange.

In addition to the above margins the Regulator/Exchange may impose additional margins on both long and short side at such other percentage, as deemed fit.

Maintenance Margin
Maintenance margin is the amount of commodity that is needed to maintain a position (stay in a trade). Initial margin is always higher that maintenance margin, so as long as the initial margin is covered, the maintenance margin is also covered. Usually, maintenance margin is approximately 75% of initial margin. When the funds remaining available in your margin account are reduced by losses to below a certain level, known as the maintenance margin requirement, you will be required to deposit additional funds to bring the account back to the level of the initial margin. Or, you may also be asked for additional margin if the exchange raises its margin requirements.
For example, if the initial margin for gold is $2,000 and the maintenance margin is $1,500, you would need to have $2,000 allocated from your account as initial margin to trade the gold contract. Should losses on your position amount to, say, $600, the value of your initial margin would be reduced to $1,400, which is below the $1,500 maintenance margin requirement. Therefore, excess funds in the amount of $600 from your account would be automatically allocated towards bringing the initial margin figure back to $2,000. If there were not excess funds in the account to bring the initial amount back up to $2,000, the trader would have to meet the margin call immediately or else the position would be liquidated.