Initial Margin vs Maintenance Margin

On a futures exchange, margin is cash or other acceptable collaterals that both the buyer and seller must deposit. Unlike margin in bond or stock accounts, there is no loan involved and, consequently, there are no interest charges. This collateral provides protection for the clearinghouse. At the end of each trading day, the margin balance in a futures account is adjusted for any gains and losses in the value of the futures position based on the new settlement price, a process called the mark-to-market or marking-to-market. The settlement price is calculated as the average price of trades over a period at the end of the trading session.

Initial margin

is the amount of cash or collateral that must be deposited in a futures account before a trade may be made. Initial margin per contract is relatively low and is approximately one day’s maximum expected price fluctuation on the total value of the assets covered by the contract.

Maintenance margin

is the minimum amount of margin that must be maintained in a futures account. If the margin balance in the account falls below the maintenance margin through daily mark to market from changes in the futures price, the account holder must deposit additional funds to bring the margin balance back up to the initial margin amount, or the exchange will close out the futures position. This is different from a margin call in an equity account, which requires investors only to bring the margin back up to the maintenance margin amount. Futures margin requirements are set by the exchange.

To illustrate the daily mark-to-market for futures, consider a contract for 100 ounces of gold that settles on May 15. The initial margin amount is $5,000 and the maintenance margin is $4,700.

On Day 0

A buyer and seller make a trade at the end of the day at a price of $1,950 per ounce and both parties deposit the initial margin of $5,000 into their accounts.

On Day 1

the settlement price falls to $1,947.50. The seller has gains and the buyer has losses.

• The exchange will credit the seller’s account for (1,950 – 1,947.50) × 100 = $250, increasing the margin balance to $5,250.
• The exchange will deduct (1,950 – 1,947.50) × 100 = $250 from the buyer’s account, decreasing the margin balance to $4,750. Because $4,750 is more than the maintenance (minimum) margin amount of $4,700, no additional deposit is required.

On Day 2

the settlement price falls to $1,945. Again, the seller has gains and the buyer has losses.

• The exchange will credit the seller’s account for (1,947.50 – 1,945) × 100 = $250,  increasing their margin balance to $5,500.
• The exchange will deduct (1,947.50 – 1,945) × 100 = $250 from the buyer’s account, decreasing the margin balance to $4,500. Because $4,500 is less than the maintenance (minimum) margin amount of $4,700, the buyer must deposit 5,000 – 4,500 = $500 into their margin account to return it to the initial margin amount of $5,000.
• At the end of Day 2, both parties have futures positions at the new settlement price of $1,945 per ounce.

Many futures contracts have price limits, which are exchange-imposed limits on how much each day’s settlement price can change from the previous day’s settlement price. Exchange members are prohibited from executing trades at prices outside these limits. If the equilibrium price at which traders would willingly trade is above the upper limit or below the lower limit, trades cannot take place. Some exchanges have circuit breakers; in this case, when a futures price reaches a limit price, trading is suspended for a short period.