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Initial Margin


Initial Margin - Definition


Initial Margin is the initial deposit you make to your broker when you open a new futures position whether long or short.


Initial Margin - Introduction



Initial margin, also known as Futures Requirement, Original Margin or Initial Margin Level (IML), is the first of three futures margins that all futures traders must be familiar with before actually trading futures. Yes, futures margin is definitely the most confusing aspect of futures trading that all beginner futures traders struggle with. Initial margin is the first of these margins and is actually nothing more than a deposit you give to your broker when you open any futures positions. This initial margin is to be paid no matter if you are the long or the short in this new position. That's right, you need to pay eventhough you are "Selling" or "writing" a new futures contract.

This free tutorial shall explain in depth what Initial Margin is, how it is calculated and how it affects your futures trading. Read the full tutorial on futures margin.


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What is Initial Margin in Futures Trading?


Initial margin is one of three margin terms that all futures traders must understand. The other two being Maintenance Margin and Variation Margin. Initial margin is the initial deposit you need to make in order to open a new futures position. Indeed, the term "Margin" in futures trading is just a fanciful industry term for "Deposit". This initial margin varies according to the underlying asset that is covered. Some assets require a high amount of initial margin while some assets require only a very low amount of initial margin. Initial margin is always calculated based on a certain percentage of the total value of the assets covered and is normally quoted directly as a dollar amount by your futures broker.

The picture below displays the actual futures chain for AAPL's June 2010 Single Stock Futures. You would see that the Initial Margin is 25% of the price of AAPL and quoted directly in actual dollar amount.

Initial Margin of AAPL Jun2010 SSF


The amount of initial margin required is this dollar amount multiplied by the contract size. In the example above, the contract size is 100 and initial margin requirement is $49.65. This means that you need to have available $4,965 for every contract you buy.





Purpose of Initial Margin


Initial Margin serves as the starting point for new futures positions from which profits will be added on to and losses deducted from. In fact, the initial margin is a kind of guarantee that you have the money to pay for your losses should losses occur right the very first day the futures position is put on. It works exactly like the chips you buy in a casino upon entering without which there is no guarantee of payment for your losses.

For instance, if you bought 1 contract of the AAPL June 2010 SSF in the picture above, you would be prompted for a "Futures Requirement" of $4,965 (contract size 100). This "Futures Requirement" is the initial margin. All you need is to have at least $4,965 in your futures trading account before you place the order and you would have fulfilled initial margin requirement.

Assuming AAPL drops by $0.50 on the very day you bought those Single Stock Futures, the loss amount of $50 will be deducted from your initial margin of $4,965 through daily settlement. This deduction of loss is the very purpose of Initial Margin in futures trading. The whole futures margin system is a mechanism to make sure parties involved have sufficient cash to cover losses in order to lower the clearinghouse's risk of guaranteeing performance.



How is Initial Margin Determined?


Initial margin is calculated as a percentage of the full contract value. The main purpose of Initial Margin is to make sure that you have enough cash to cover losses incurred due to a large single day move. As such, initial margin requirement is generally determined based on the volatility of the asset being covered. The more volatile the underlying asset is, the higher the margin requirement would be. In the US market, the Financial Industry Regulatory Authority (FINRA) requires all initial margin to be at least 25% of the value of the asset covered. If an asset is deemed to be volatile, your broker may require as much as 50% as initial margin. All Single Stock Futures traded in the US market requires 25% initial margin.

Initial margin requirement can change as the volatility of the underlying asset changes but such changes do not happen often. However, it is common for initial margin requirement for futures contracts of different expiration months to be different, as such, you need to be sure to check the initial margin requirement of the different futures contracts you are trading even if they are of the same underlying asset but different expiration months.

Initial margin requirement is typically lower when you put on a futures spread rather than an outright futures position due to the lower risk and volatility of a spread position.


OppiE's Note It really isn't that important to know specifically how the initial margin rate is determined. What is important is that you know exactly how much is required.



Latest Development in Initial Margin Requirement


More and more clearinghouses and futures exchanges around the world are adopting what is known as SPAN Margin. SPAN is short for Standardized Portfolio Analysis of Risk. This is a complex computer system that attempts to determine the worst possible single day move of a futures position and determine the initial margin requirement based on that calculation instead of applying a standard rate across the board in all market conditions. The objective of SPAN margin is really to lower initial margin requirement to more realistic levels so that futures trading becomes more accessible. This system also rewards sophisticated futures traders who apply hedges to their positions in order to lower risk and therefore initial margin requirement.

Read the full tutorial on SPAN Margin.




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Futures Margin
Variation Margin
Maintenance Margin
Margin Call
Futures Contracts
Single Stock Futures
Futures Trading

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