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

2. 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

3. 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

4. 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

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