Wikipedia of Finance - e-learning course on Futures Trading Wikipedia Chapter - Margin and M2M (Mark to Market)

What is Margin and M2M (Mark to Market) in Futures Trading of Derivative Market


Margin Definition:

The main objective of these investments is to make a margin and help to mitigate the risks. Traders utilize futures contracts as a method to minimize price fluctuations. For example, if a seller of soybeans knows you will have a certain amount produced in the future, you can sell a futures contract on soybeans. In this way, the seller will not have to worry about what the market prices for soybeans are when they are ready to sell. Option contracts can do the same as it ensures that the contract holder may buy or sell at a certain price. If prices change quickly before the expiration date, the contract owner has some built-in protection.

The margin is directly proportional to the risk and volatility. That means, the when the market will become volatile, the margin will increase. The client accounts are set for a specific percentage of day trade margins with the online futures trading platforms.  Also, the clients are offered a lower day-trade margin requirements to the clients that are active futures traders.

With their trading system, all derivative trades that are placed by clients are considered to be day trades unless they are held past the closing of the trading session.  As a futures trade is held past its closing time, it becomes a “position” trade and is subjected to the full margin requirements.

When it comes to dealing with the options and futures market, one may take part in any number of underlying commodities or securities. Derivative markets include various types of products. For example, one may buy or sell futures contracts on medicines, gold, corns, and oil. Options can be used in any of these products or securities such as stocks. Virtually any financial instrument can have an option that makes it an investor.

Margin Example:

Suppose, In derivative market, Mr. James, a Jeweler agrees to buy 25Kgs of Gold at Rs.2450/- per gram of future 3 months contract starting today from seller Mr. Roy, a Gold Dealers with the margin payment of approximately 10% of the trade value. It is clear that any variation in the price of gold will directly affect Mr. James or Mr. Roy. If gold price increases then Mr. Roy will suffer a loss and Mr. James makes earn a money. Whereas, if gold price decreases Mr. James will suffer a loss and Mr. Roy will makes a profit.

Mark to Market (M2M) Definition:

Since price of the futures contract keeps on fluctuating on a daily basis, which conclude that every day you either make a profit or a loss. Mark to market (M2M) or Marking to market is a procedure which adjusts your profit or loss on day to day basis as long you hold the futures contract.

Mark to Market (M2M) Example:

Assume that you decided today to purchase NIFTY future at Rs.7,500 with margin payment of 10% as mentioned by government regulatory body. Which means that to hold the NIFTY future contract, you need to maintain 10% of margin on daily basis. Suppose one fine day NIFTY future contract is down by 15%, In that case your daily Mark to Market margin goes into negative value. In other words, if you want to further hold the NIFTY future then you will have to allocate funds to maintain 10% margin on daily basis else the future contract will get square off by regulatory body due to insufficient funds.

Derivative Market and Rules:

There are basically two types of futures trading rules observed by traders. There are regulations and exchange rules that must be obeyed no rules and business practices collected from successful traders. The money regulatory rules are made to deal with the rules of the fair trade market and increase the inability of traders to follow reasonable rules. Rules change refers to the contract specifications, trading hours and leverage.

The government’s role in the futures markets is primary to define rules by which exchanges and brokers should behave. The government acts more as a disciplinary and regulatory body with much of the specific rule that leaves the brokerage and exchange. Regulatory rules are concerned about the availability of transparent information to all buyers and sellers and the application of rules to control unfair advantage through market manipulation.

Rules change care about the details of futures trading. Exchanges, under review by the Commission Futures Trading Commodities (CTFC), determine the position limits that can be held by any trader one hand, the definitions of the size and quality of contracts standard futures, hours of operation and in which contracts months there will be (usually trade contracts one month in each quarter), and the point value (minimal movement) of the contract. The most important thing is the change determines the minimum margin or the amount that a trader must deposit to negotiate a contract.

Money management is absolutely essential for good trading futures. Money management is determining how much risk is the optimum amount to be employed in any trade. The modern theory uses variables risk strategies. Instead of investing, say, 5 percent per trade, money management variable attempts to change the investment based on prior success or failure of the operation and the total number of dollars available for investment. Operators recognize that the probability of success in a trade is a function of whether the market is a bearish, bullish or neutral phase.

Once a futures trader has adopted a rule of money management, the next step is to design a safe and effective plan. Protective stops are used in combination with the input signals to initiate a trade. Protective stops are placed below the entry point and represent the amount of the maximum loss that a trader is willing to absorb in any trade. It is also the point where the discipline of a proven trader is more. Protective stops represent an important opportunity to avoid small losses become big losses. Importantly, protective stops, known as drag losses, should be used throughout the period of tenure of office until the exit strategy is activated. Establish a protective stop rule cannot be underestimated. Traders should avoid the temptation to issue a stop carefully constructed.

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