Commodity Futures Margin, Your Trading Foundation
Before starting to trade commodities you need to look at the concept of commodity futures margin and how this impacts on the whole process.
A futures margin refers to the amount of capital a commodity trader has to put up before they can open a futures contract.
Margin levels are worked out by the commodity futures exchange and broker members may also add a premium to act as an insurance to protect themselves.
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The margin rates are usually set in proportion to the expected volume and size of the movements in futures markets.
If unusually volatile trading conditions are anticipated, the futures exchange authorities can act quickly to increase margins.
Initial Margin
When a commodity trader opens a trading account with a broker, he or she is required to put down a capital sum.
This acts as a form of collateral and allows the commodity trader to then enter futures contracts in the markets.
Each commodity exchange will set out what are the initial margin levels for each commodity traded.
The initial margin is a reference point and there is a level below this which if triggered by a fall in the value of the account will result in the trader having to top up their account.
Margin Maintenance Level
As a trader you must keep funds in your account above the margin maintenance level.
Let’s say for example that a wheat futures contract has a margin of $1,000 and a maintenance margin of $600.
So you start off with the initial margin of $1,000, but then the wheat price falls and your futures contract value falls to $450 on this account.
The maintenance level ($600) has been breached and so you as a trader has to top up $450 as extra margin to recover the initial maintenance margin.
Margin Call
When the value of your commodity trading account falls below the maintenance level, you will receive a margin call from the brokerage requesting extra funds to bring the account back to the level of the initial margin.
If the value of the futures contract falls to say $7,500, you will get a margin call and have to add a further $2,500.
Keep an eye on commodity futures trading rule changes.
You should be aware that the rules for commodity future trading accounts can allow for changes to initial and maintenance margin levels, depending on the market conditions.
The commodity exchange will usually inform brokerages of these changes in regulations.
As a trader you need to make sure you are aware of possible changes to commodity futures margin requirements, as these can impact on the way you conduct your trading, or even whether you wish to continue to trade commodities.
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