A Note On Currency And Index Futures
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TYPES OF MARGIN:The clearing house stipulates
the margin to manage the credit risk assumed by it. These margins are of two
types – Initial margin, and Maintenance margin. An example will help us to
understand the different kinds of margin.
Example:
On February 3, 2003, an investor buys two March 2003 gold futures contracts on the New York Commodity Exchange (COMEX). The current futures price is $500 per ounce and the investor buys 200 ounces at this price. The minimum contract size is 100 ounces. The investor has to deposit the money in an account which is termed as the margin account. The amount to be deposited initially is called the initial margin and varies from one contract to another depending on the volatility of the underlying asset.
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Let us assume that the initial margin is $5000. The
investor also has to maintain at least 75% of the initial margin, also
known as maintenance margin, to ensure that the balance in the margin
account does not become negative. The margin account is adjusted at the
end of each trading day reflecting the investor's gain or loss. The
maintenance of these margins ensures that the exchange is safeguarded
against any default risks.
Let us assume that by the end of the first trading day, the futures
price of gold has fallen from $500 to $495 resulting in a loss of $1000
(200 X $5) to the investor. The margin account will be adjusted and the
account balance will be reduced by $1000 to $4000 at the end of the
first trading day. Assume that from February 3rd to 10th, the future
prices of gold are as follows: |
|
|
Day |
Futures Price |
Daily Gain/(loss) in $
|
Cumulative Gain/(Loss) in $
|
Balance in Margin A/C
|
Margin Call in $ |
|
|
$500.00 |
|
|
$5,000 |
|
|
3-Feb |
$495.00 |
-1000 |
-1000 |
$4,000 |
|
|
4-Feb |
$494.00 |
-200 |
-1200 |
$3,800 |
|
|
5-Feb |
$492.50 |
-300 |
-1500 |
$3,500 |
1500 |
|
6-Feb |
$493.00 |
100 |
-1400 |
$5,100 |
|
|
7-Feb |
$494.00 |
200 |
-1200 |
$5,300 |
|
|
10-Feb |
$492.00 |
-400 |
-1600 |
$4,900 |
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The investor can withdraw any balance in
the margin account in excess of the initial margin. When the balance in the
margin account falls below the maintenance margin (75% of the initial
margin), the investor will receive a margin call and will be required to
reset the balance to the initial margin level. The additional money
deposited to bring the margin account to the level of initial margin is
known as the variation margin.
SETTLEMENT PROCEDURES
APPLICATIONS OF FUTURES
TYPES OF FUTURES
TRADING USING CURRENCY FUTURES
TRADING USING INDEX FUTURES
CONCLUSION
EXHIBIT I DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
EXHIBIT II A NOTE ON ANALYZING FUTURES PRICES
ADDITIONAL READINGS AND REFERENCES
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