What Is MTM?

You enter the financial market with Rs 1,00,000 capital. You do your research and invest them in good financial assets. After some time, you make Rs 30,000 as profits on the initial capital you invested. Since you made over 30% profits, you regret not investing more than Rs 1,00,000. Suppose you had invested Rs 5,00,000, the profits would have been 1,50,000.

This is a common principle in the financial market: the higher the capital, the higher the profit potential. However, experienced investors know that to invest such a huge capital would mean cutting out a large portion of their savings which they may need for other expenses.

Hence, they switch to derivatives where they don’t have to pay the entire capital themselves and can buy more expensive contracts. A derivative is an instrument that derives its value from the underlying asset. The asset can be equity, a commodity, a currency, or even an index. Derivatives are usually in the form of a contract, where the buyer is obligated to buy, or the seller is obligated to sell the underlying asset at a specified price on a specified date in the future.

Within the asset class of derivatives, there are two contracts:

• Futures Contract:A futures contract is an agreement between the buyer and the seller of a particular asset. The buyers purchase a specific quantity of the asset at a predetermined price payable at a specific time in the future. This contract remains until maturity, and investors can sell them if the price has risen at the time of the expiry to make a profit.
• Options Contract:An options trading contract is generally permitted in top assets wherein the trader has the right but not a legal obligation to buy/sell the purchased security at a fixed price. Such a contract helps investors make a profit based on price fluctuations without having to buy/sell the contract.

In Options trading, investors use margin as a way to leverage and buy contracts over their budget. This blog details an integral aspect of Futures trading through margin called MTM (Mark-to-Margin) and how it influences the process. But first, let’s understand Margin.

How does margin work in trading?

Margin trading is a type of investing style that involves buying stocks that are expensive and over your current budget. Through margin, you can buy stocks by paying only a small percentage of their prices, and the rest is provided by the stockbroker.

This margin amount is then paid with interest back to the broker. Until then, the broker holds the securities as collateral. If the profit you earn through the sale of the stocks is higher than the margin amount, you earn a profit. If not, you incur losses after settling the margin amount and squaring off the stock positions. You can manage these processes efficiently using an online trading app.

Types of Margin

There are two types of Margin charged by brokers:

• SPAN Margin:

  It is the basic required margin blocked by a stockbroker for Futures and Options contracts. It is calculated through the Value at Risk (VAR) method. Exposure Margin: This type of margin is blocked by the stockbrokers over and above the SPAN Margin to settle any MTM losses.

What is MTM?

In financial terms, MTM or Mark to Market refers to the value of any asset as the current fair value after price or value fluctuations. Mark to Market is a method that aims to determine the real and fair value of a company’s financial situation based on the current market situation that is affecting the company’s performance. For example, if a bank or a financial company has realized losses because of bad loans, the total bad loans amount is adjusted in the balance sheet to determine the current fair value of the business. Hence, it is called Mark to Market.

However, the same term Mark to Market or MTM becomes Mark to Margin in the investing spectrum but is still widely referred to as Mark to Market. MTM in the investing market refers to the settlement of the daily gains and losses based on the price changes in the market value of the asset. Mark to Market is majorly used in the trading of Futures Contracts. If the value of the underlying asset goes down in a day, the seller of the contract collects money from the buyer. In case the price of the underlying asset goes up, the buyer collects money from the seller of the contract. This settlement is called MTM or Mark to Market and is done daily.

Understanding the nuances of Mark to Margin (MTM)

The prices of the futures contract fluctuate daily and can result in profit and losses for the buyers or the sellers. The MTM or Mark to Market settles these profits and losses daily by adjusting the initial margin (SPAN Margin + Exposure Margin).

Here is a detailed example to understand how MTM or the Mark to Market works in Futures contract:

Suppose you buy the Futures of ABC company at Rs 150 with a lot size of 1,000 and square off your position after 3 days. The closing prices for 3 days are listed below:

• Day 1: Rs 155
• Day 2: Rs 160
• Day 3: Rs 158

Without MTM or Mark to Market, you would have gained Rs 8,000 (158-150=8x1,000) after the end of three days. However, because of MTM or Mark to Market, the profit and losses are settled daily.

When you purchased the Futures contract, the price was Rs 150. But on Day 1, the price rose to Rs 155. In this case, your profit would be Rs 5,000 (155-150=5x1,000). This amount is credited to your trading account on Day 1 after the daily settlement.

The amount of profit, i.e. Rs 5,000 is debited from the seller’s trading account. The amount is withdrawn from the initial margin amount that the stockbroker blocks when getting into the trade. From Day 1 onwards, the price of the Futures Contract is treated as Rs 155, as the Rs 5 difference for 1,0000 shares has already been credited to your trading account. For Day 2, you will again receive Rs 5,000 as the price rose 5 points to Rs 160. However, for Day 3, your Margin account will be debited by Rs 2,000 as the price decreased from Rs 160 to Rs 158. This amount of Rs 2,000 will be credited to the trading amount of the seller.

How does the Margin call occur?

Now that you know what is MTM in trading, what happens if you are obliged to pay a certain amount and your margin amount falls short? That is when the Margin call occurs. A margin call is made when the initial margin balance falls below the maintenance margin. That is the point, the broker will make a margin call to the client to top up the trading account with more margins to avoid unnecessary risk. If the client does not bring in the additional margins on margin call, the broker is at liberty to dispose of the position in the market to recoup their loss.

In simple words, you will have to provide the balance money needed to give to the other party in case the price of the futures contract declines before the daily settlement. Once you provide the balance margin amount to the stockbroker, you can move ahead with your positions and square off according to your preference.

Conclusion

MTM or Mark to Market is a great way to avoid trading risks. As the profits and losses are settled daily, you are at a lesser risk of wiping out the profits you earned one day because of the losses you incur on the next. As you realize profits, if any, daily, you know where you stand and can square off your positions as soon as your investing goals are achieved. This also allows you to manage your risk profile as after incurring certain losses, you can identify an exit point and ensure you do not incur further losses.