Margin is the deposit money that needs to be paid to buy or sell each contract. The margin required for a futures contract is better described as performance bond or good faith money.
In the futures market, there are different types of margins that a trader has to maintain.
• Initial margin: The amount that must be deposited by a customer at the time of entering into a contract is called initial margin. The margin is a mandatory requirement for parties who are entering into the contract meant to cover the largest potential loss in one day.
• Maintenance margin: A trader is entitled to withdraw any balance in the margin account in excess of the initial margin. To ensure that the balance in the margin account never becomes negative, a maintenance margin, which is somewhat lower than the initial margin, is set. If the balance in the margin account falls below the maintenance margin, the trader receives a margin call and is requested to deposit extra funds to bring it to the initial margin level within a very short period of time.
• Additional margin: In case of sudden higher than expected volatility, the exchange calls for an additional margin, this is a preemptive move to prevent breakdown. This is imposed when the exchange fears that the markets have become too volatile and may result in some payments crisis, etc.
• Mark-to-Market margin (MTM): At the end of each trading day, the margin account is adjusted to reflect the trader's gain or loss. This is known as marking to market the account of each trader. All futures contracts are settled daily reducing the credit exposure to one day's movement. Based on the settlement price, the value of all positions is marked-to-market each day after the official close. i.e. the accounts are either debited or credited based on how well the positions fared in that day's trading session. If the account falls below the maintenance margin level the trader needs to replenish the account by giving additional funds. On the other hand, if the position generates a gain, the funds can be withdrawn (those funds above the required initial margin) or can be used to fund additional trades.
In addition to initial margin, additional margin, long margin / short margin and regulatory margin may be levied and changed time-to-time as per the Exchange Policy based on market volatility. Value at Risk (VAR) is a technique used to estimate the probability of loss of value of an asset or group of assets based on the statistical analysis of historical price trends and volatility.
Financial safeguards provided by DCX Nepal clearing protect the financial interests of both parties in a trade, leading to sound markets and deeper liquidity.
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