How does futures margin work?

When a futures contract is being traded, both the buyer and seller are required to put up a good-faith deposit, called a margin requirement. Think of it like collateral - the buyer and seller are putting up “skin in the game”. When the position is closed, the margin requirement is returned, plus or minus any gains or losses and net of commissions and fees.

Margin requirements differ for each futures product. The size of the contract, also called the notional value, is one of the main things that affects the required margin. While the amount can vary, it’s typically a fraction (roughly between 3% and 12%) of the futures contract's notional value. Another factor affecting the margin requirement amount is the volatility of the underlying asset. The more volatile a futures contract is, typically the higher the margin requirement and vice versa.

Example

Assume the current price of a Gold futures contract (/GC) is $2,000 per troy ounce and the margin requirement for the contract is $13,000. This is the amount the trader must have in their account to open a position in one /GC futures contract. Because one /GC contract represents 100 troy ounces, the notional value of one contract is $200,000 (100 x $2,000). Since the margin required is only $13,000, the trader is essentially putting up 6.5% of the total value of the contract as a good-faith deposit. Once the position is closed, the $13,000 will be returned to the trader, plus any gains or minus any losses, net of commissions and fees.

Futures contracts have margin requirements to ensure that both parties in the trade have enough capital to cover potential losses and fulfill their obligations. Because futures are agreements between two parties, the margin serves as a type of assurance that the trader is committed to the contract and will honour its terms. Even though most traders don’t hold futures to expiration, the good-faith deposit makes sure that both parties are adequately capitalised.

Margin requirements play several other critical roles:

1. Risk management: Margin requirements help ensure that traders have sufficient funds to cover potential losses, reducing the risk of default on the futures contract, protecting both the traders and the brokers involved.
2. Leverage: Futures trading employs significant leverage as a result of how much margin is required on the total value of a position. Leverage enables traders to control large positions with a relatively small amount of capital, which can amplify profits and losses. Margin requirements can be raised to regulate this leverage and provide a degree of protection for brokers and exchanges during volatile markets.
3. Market stability: Requiring traders to maintain adequate margin levels reduces the likelihood of forced liquidations and market disruptions caused by undercapitalised traders.

The term margin can have different meanings in the financial world, and margin for stocks is different from margin on futures. While the required margin to open a futures trade represents a good-faith deposit, margin in the stock market means borrowing money from your broker to buy stock and using your existing stock as collateral. You’re not borrowing money when you trade futures.

In contrast to futures margin, which is typically a fraction of the notional value of a futures contract, margin for stocks is controlled by Regulation T (or “Reg T”). Reg T allows for investors to borrow only up to 50% of the value of the stock being bought. As an example, in a margin account, you can typically buy $5,000 worth of stock with $2,500. However, your broker might require more margin in some cases, but the amount can never be less than the 50% required under Reg T. Like futures, stock margin can result in a margin call if the account value drops below a certain level. Learn more about equity margin calls.

Once the position is open, the fluctuation in price of the futures contract will result in your P&L moving up and down. If you close your position, your margin requirement will be returned to you plus any gains or minus any losses, net of commissions and fees. If you hold a futures position from one day to the next, the position will be marked to market (the process of adjusting the value of open positions at the end of each trading day based on the daily settlement price, ensuring that gains or losses are settled daily in the trader's account). For example, a long position that increases in value and is marked to market at the end of the day will result in a positive increase in your account value.

If the account dips below the required margin, your broker will likely issue a futures margin call. If the margin call isn’t met, your broker might liquidate all or part of the position to cover the margin deficit, likely resulting in a losing trade. Many traders keep additional funds in excess of the margin requirement in their account to avoid forced liquidations if there’s a margin call.

Each futures contract has a notional value based on current prices and the quantity specified by the terms of the contract. It’s calculated by multiplying the contract multiplier by the current price. For example, one /GC contract represents 100 troy ounces of gold. If the current price is $2,500, the notional value of one contract is $250,000, two contracts is $500,000, three contracts is $750,000 and so on. Think of notional value as the cash equivalent value of the futures contract. It will change over time as the price of the underlying futures moves higher and lower.

The futures exchanges set margin requirements for futures and your broker might have additional requirements beyond the minimum. In addition, margin requirements can change depending on the future’s price and market conditions. During periods of high volatility, the exchanges or your broker might increase the amount of margin required. The opposite is also true when volatility ebbs.

Futures exchanges offer smaller versions of existing futures called “micros” that have smaller margin requirements and control a smaller amount of notional value. For example, CME Group has a number of micro contracts that represent much smaller versions of /GC, WTI Crude Oil (/CL), E-Mini S&P 500 (/ES) and others. Margin requirements on micro contracts are usually a fraction of the margin required on standard contracts. Just as with margin on standard contracts, margin on micros can change over time as well.

Notional values and margin requirements increase along with the number of contracts traded. For example, if the notional value of /GC is currently $200,000 and the margin is $13,000, then the notional value and margin requirements for two /GC contracts are $400,000 and $26,000, respectively.

Let’s say you wanted to buy a total of four Micro Gold futures (/MGC) and buy them two at a time. If the current margin is $1,300, your margin requirement on the first two is $2,600 and the next two is $2,600. The total margin is therefore $5,200 ($1,300 x 4). If gold prices drop and the account falls below the required margin, it might result in a margin call. At that point, additional funds would be required or the call could possibly be satisfied by closing part of the position, such as selling one contract, to close.

While required margin generally increases as you increase the number of contracts you’re buying or selling, the maths can sometimes get a little more complicated when simultaneously trading in different expiration months (such as buying in one month and selling in another) or going long and short two similar futures (like /GC and /MGC). As a general rule, the higher the total notional value and the more risk, the greater the required margin.

The futures margin requirement is the amount of money you need to open a futures position. It is determined by the exchange and your broker and ensures traders have the minimum funds to cover potential losses, manage risk and maintain market stability. As with any financial instrument, be sure to thoroughly understand the mechanics of futures margin requirements and margin calls before placing a trade.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Futures are complex products with a high risk of losing money rapidly due to leverage. They’re not suitable for all investors. Before you invest, you should make sure you understand how futures work, what the risks are of trading futures and whether you can afford to lose more than your original investment. Please review the Futures Risk Disclosure Statement prior to engaging in futures trading.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.