Chapter 5: How Much Money is Required for Futures Trading?
The minimum amount of money required to start futures trading is the “Margin Money”, an amount that is a portion of the futures contract calculated and fixed by exchanges.
Remember, futures are standardised exchange-traded contracts and the exchange plays a major role in clearing and settlement to counter the risks of default.
To eliminate such a risk, the exchange has amechanism where a futures trader must maintain a minimum balance deposit with a broker or the exchange as Margin Money.
In case one party to the contract defaults, the exchange will deduct the losses from the margin deposit of the other party and compensate the other party. That’s how the exchange risk management mechanism works.
Since margin calculations are established on the future contract value, any change in the volatility of these contracts could increase the risk of default. This leads to exchanges increasing margin requirements.
It is, therefore, crucial for every trader entering the F&O markets to understand how margins are calculated. Let’s tackle the entire concept of margins step by step.
4.1 What is Margin?
An exchange demands Margins (initial + exposure margin + VaR margin) that can vary from 10% to 20% or even more, depending on how volatile is the underlying asset, plus a Daily Settlement of MTM – marking the profits or losses to the market prices at closing ( Daily MTM ) from both parties. All of this is required to manage risk.
We shall see how exchanges use tools for risk management in the coming chapters. For now, let’s dig into how margins are calculated mathematically and derive the margin prerequisites for a trader who wants to start futures trading. This will solve the most important question – How much money is required to trade a futures contract.
4.2 Margin Calculation for Stock & Index Futures on NSE
NSE has a comprehensive risk containment instrument which defines the margin requirements in a stock or index based on its volatility and some defined standards for the F&O segment.
The most crucial component of a risk containment mechanism is the online position monitoring and margining system.
The actual calculations of estimation of margins and positions monitoring is done on a real time basis. NSE Clearing uses the SPAN (Standard Portfolio Analysis of Risk) system for the purpose of margining, which is a portfolio-based system.
For Dhan users, the app calculates the required margin as per the exchanges on a real-time basis. Thus, instead of getting into the complex calculations, let us show you how margin requirements work.
Let us assume that you are bullish on companies making EVs in India and have an eye on Tata Motors.
Suddenly the management of Tata Motors launches 4 to 5 new EV models. That’s the trigger you were looking for, sufficient to create a directional bullish view of the stock.
That’s why you decide to buy Tata Motors Futures. Here’s how much margin you need in your trading account to take a position.
Margin for Trading Futures
1 Lot = 1,425 shares
Margin Required = 26.84%
Contract Value = Lot size * CMP of Futures
= 1,425 * 397
= 5,65,275
Margin amount = 5,65,275 * 26.84%
= 1,51,840
Leverage = Contract Value/Margin Amount
Leverage = 4x
To buy a futures contract of Tata Motors stock, you will need INR 1,51,840 as a minimum balance in your trading account as a margin.
Another example we can take is Index Futures. RBI indicates that they are about to increase interest rates in the economy to curb inflation.
Direct beneficiaries of the increase in interest rates are banks, as now they will charge higher interest rates to their clients. This would increase their profits and share prices too shortly.
You are bullish on the banking sector and decide to buy Bank Nifty futures since shares of all banks are the underlying asset. Hence, instead of choosing a particular banking stock, you take a long position in the Bank Nifty futures. Here’s how much money you need for the trade.
Margin for Bank Nifty Futures
1 Lot = 25 shares
Margin Required = 14.86%
CMP = 39,290
Contract Value = Lot size * CMP of Futures
= 25 * 39,300
= 9,82,250
Margin amount = 9,82,250* 14.86%
= 1,45,962.
Leverage = Contract Value/Margin Amount = 6.73x
Let’s take another example, suppose you want to buy gold from MCX which is a leading commodities exchange in India, the CMP Gold futures traded on MCX is 50,200.
Margin for Commodity Futures
1 Lot = 100 shares
Margin Required = 7.26%
Contract Value = Lot size * CMP of Futures
= 100 * 50,200
= 50,20,000
Margin amount = 50,20,000* 7.26%
= 3,64,452
Leverage = Contract Value/Margin Amount
= 13.78x
As you can see, different future contracts have dissimilar margin requirements set by the exchanges with varying methodologies.
This demonstrates that margins are set by the exchange based on the volatility of the underlying asset.