FAQ: What is a Margin?

Many of those new to trading will have difficultly understanding the concept of a margin. This short article puts things in perspecitive.

When you hire a car, you pay a deposit. When you take out a home loan, it is normally secured by a mortgage. Why do you have to do this? It is because there is a liability that may have to be covered. You might smash the rental car or you might be unable to meet your loan repayments.

Futures and options trading is no different. Buying or selling futures or selling options leaves you open to a liability. Given this, the exchange clearing house and your broker will take measures to ensure you are able to meet your financial requirements, should the position move against you.

There are a number of different methods of covering this liability, depending on the underlying asset itself and the exchange on which it is traded. The requirements may differ from exchange to exchange but generally speaking, a holder of a futures contract or a short option will be required to lodge and maintain a deposit called a “margin”.

A margin is like a deposit that is revalued every day, based on specific risk calculations. If for example you are short out-of-the-money call options and the market kept moving against you, your daily margin would increase.

Generally speaking, the clearing house of the exchange will set the deposit or margin required for futures or short options but in most countries, a broker has the right to increase the requirements for one or all of its clients.

Before trading in a certain market you should speak with your broker and check out the exchange website regarding requirements for trading in short options.

For future options, just remember that a margin can never get any great than the corresponding futures margin since the delta (risk) of an option can never be greater than 1.0. However, it is your mark-to-market valuation that can cause problems if the market is going against you.

You can think of a margin as a measure of your risk at a single point in time, but not a measure of your total risk moving forward.