What is margin money?

In any business, you pay margin money to show your commitment and this gets adjusted to the final price. The same applies to trading in the stock markets also. When you take delivery of the stock, you need to anyways pay the full money to the exchange by the next day of the trade or T+1 as we call it.

For example, margins are payable for intraday positions. Margins are also payable for buying futures, selling futures, and for selling options. For buying options there is only the premium margin money that is payable. Let us understand what is margin money and margin money means concerning futures and options. As the name suggests, margin money is a part of the full price that you pay to show your commitment to the transaction and to cover part of the risk of price movements.

Exactly What is margin money

What is margin money in share trading will focus largely on the futures and options side of the stock market. Margin money is collected as collateral which the trader has to deposit with the exchange. Margin money shows the commitment of the trader and partially covers the risk in the trade is open for the day. There are different conditions under which margins are payable.

• When you buy stocks on margin via borrowed money
• When you take an intraday position, either long or short
• When you buy or sell futures
• When you sell options

Understanding margin money and margin collection for futures

The most important margin is the initial margin. The initial margin is calculated as the sum of the SPAN margin and exposure margins. In the past, it was only mandatory for brokers to collect the SPAN margins from clients for futures trades, and collection of exposure margins was optional. However, in the last 2 years, SEBI has made it mandatory for brokers to collect the SPAN margin and the exposure margin. The combination of the two becomes the initial margin for the futures contract.

Before we get into the specifics, let us understand how the margin waterfall works. When the futures long or short is initiated, the client has to pay the SPAN + exposure amount as the initial margin. However, that is just the basic margin. Daily, there are the MTM or mark-to-market margins. In these MTM margins, your positions are daily marked to market and the margin is accordingly either debited or credited to your margin account. For example, MTM profits are added to your margin money and MTM losses are deducted from your initial margin money. The exchange has also set a level called the maintenance margin level, which is below the initial margin. If the initial margin amount is reduced to below the Maintenance Margin level due to losses, the broker will instruct the trader to top up the margin. This difference that is payable is called the Variation Margin and the process of asking the client for more margins is referred to as the Margin call.

Here is how the initial margin calculation in futures trading works

Initial margin or the base margin money is the fund deposit required when you initiate a futures trade. It can either be a long trade or a short trade in futures. Also, similar margins will apply on a stock, irrespective of whether you are going long or short. The margins are based on a concept called value at risk or VAR. It calculates the maximum loss that can be incurred in a single day in a worst-case scenario. The ball game is slightly different concerning initial margin money on options. Initial margins are applicable only when you sell options and this margin is adjusted by the premium received.

The initial margin is not fixed but changes daily. It is based on the notional value of the futures contract. More volatile stocks will have higher initial margins and less volatile stocks will have lower initial margins. Index margins will always be lower than stock level margins. Initial margins for index futures and stock futures are calculated using a system known as “SPAN Margin” which is a portfolio approach to the calculation of margins.

Let us turn to the all-important maintenance margins

Initial margins are only for Day-1. It does not cover the day-to-day risk, which is done by MTM margins. However, MTMs can be positive and also negative. If the MTMs are positive on 3 days and negative on 3 days, the net impact may not be much. However, what happens if your position makes successive losses so that the initial margin adjusted for MTM losses is much below the original level? Here, the concept of maintenance margins kicks in. The broker will initiate action only when the initial margin balance goes below the Maintenance Margin required of the position.

You will recollect from the earlier part of this note that maintenance Margin is the minimum amount of margin that you need to maintain in your account to keep your future position valid. If the margin money goes below the initial margin but is still above the maintenance margin, then brokers are ok. But the alarm bells will only sound once the balance goes below the maintenance margin That is when the broker will trigger the margin call. In this margin call, the broker asks the client to top up the account with more margins. However, if the client is unable to bring in the top-up margins, then the broker is at liberty to close out the position in the open market.

Uses of margin

Why do we need margins? Firstly, margins show the commitment of the trader to the trade. A trader with commitment will always honor the trade. Even if they get into a financial problem, the exchange and the counterparty are safe as they have the initial margin to fall back upon.

The MTM margin is about managing the daily risk. You get credit for positive price movements and debits for negative price movements. The timely collection of margins has contributed in a big way to making the markets safer, sounder, and more secure as the risks are managed a lot better.

What is the expiry date?

The expiry date in the futures contract is the last Thursday of the month when the futures and options contract expires. All open contract positions are automatically closed out at the closing price. After the expiry date, the near-month contract expires and a new far-month contract is introduced for trading.

What is margin money?

Margin money is part of the price that we pay to the exchange as caution money or earnest deposit to show our commitment to the trade and to honoring commitments. It also makes the exchange mechanism safer as defaults are unlikely to impact the functioning of the stock exchange. In the process, traders and market participants also benefit from the same.