Financial Market Theory Thursday, November 16, 2017 Professor Edwin T Burton

Trading Futures – Margin Calls Good Faith Deposits You really own nothing until the delivery date Instead you have put up a good faith deposit Called “initial margin requirement” No loan is created (very similar to house purchase Mark-to-market Daily and immediate Compares price on last night’s close to price on prior day’s close Any difference must be ‘marked’ in cash But, good faith deposit can be collateralized Margin requirements can be changed at any time

Suppose you buy a future for $ 1,060 Suppose “initial margin requirement” is ten percent Then you “put up” $ 106 per futures contract as “good faith” If price ends at $ 1,050 at the end of the day, you will owe $ 10 the following morning in additional required margin (this is known as a “margin call” If price ends at $ 1,070 at the end of the day, you will be credited with $ 10 in cash for each contract you ‘own’…you may withdraw this from your account immediately And so forth

Trading limits The exchange can impose ‘trading limits’ E.g. Gold futures may be limited to a range of $ 100 per day Thus, if gold futures were $ 1,060 on last night’s close: It may not trade below $ 960 or above $ 1,160 the following day This is called a ‘lock limit’ Speculator can get trapped by such limits It is customary to double the width of the trading limits on the following day In our example, the limits might be expanded to $ 200 per day on the day following the imposition of the $ 100 limit Limits are at the complete discretion of the exchange and may be changed at any time

Failure to meet a margin call Will result in immediate liquidation by the exchange This is called a “margin call liquidation”