If you have understood all these things properly. So we go ahead and talk about margin and mark to market.<\/p>\n
Why is margin charged?<\/h2>\n
For a more in-depth understanding of margins, let us once again return to our example with ABC Jewelers, which we discussed in Chapter 1. ABC Jewelers entered into an agreement to buy 15 kg of gold at Rs 2450 per gram after 3 months from XYZ Gold Dealers. Now we know that if there is any movement in the price of gold then ABC and XYZ will gain and the other will lose. Suppose the price of gold moves very high and XYZ becomes very difficult, then XYZ can say that it cannot complete the deal and defaults. This will be followed by a long period of court battle. But the point of work for us here is that defaulting in such a situation is quite an easy path. Since the futures market is also built on the basis of the forwards market, therefore, understanding this possibility of default, some important changes have been made here and margin has been given an important role.<\/p>\n
There is no regulator in the forward market. The agreement is between two people or two parties and no third person has any knowledge of it. Whereas in the futures market, all the transactions take place on an exchange, the exchange guarantees their settlement. Meaning the exchange ensures that you get your money when the deal is completed. That’s why the exchange takes money from all the parties first.<\/p>\n
How do exchanges do this and how do they ensure that all this happens smoothly? It happens-<\/p>\n
- \n
- By Taking margin<\/li>\n
- By keeping a record of the profit or loss that occurs every day, which is called mark to market or M2M<\/li>\n
- It is important for you to understand the principle of margin and mark to market properly because only then you will be able to understand the working of this market properly. But explaining these two together is a bit difficult task, so first I want to explain to you Mark to Market i.e. M2M. To understand this you have to remember a few things.<\/li>\n
- Margin money gets blocked in your trading account as soon as you take a position in the futures market<\/li>\n
- The margin that is blocked is called the “Initial Margin” or opening margin.<\/li>\n
- There are two parts of the initial margin, the SPAN margin and the exposure margin.<\/li>\n
- Initial Margin = Span Margin + Exposure Margin (Initial Margin = SPAN Margin + Exposure Margin)<\/li>\n
- The initial margin block remains in your trading account as long as you stay in that trade.<\/li>\n
- The amount of initial margin varies from day to day as it depends on the price of the futures<\/li>\n
- The initial margin is a fixed percentage of the contract value.<\/li>\n
- Contract Value = Futures Price \u00d7 Lot Size<\/li>\n
- Lot size is fixed but futures price changes every day that means margin also changes every day<\/li>\n
- Now let us go ahead and try to understand M2M.<\/li>\n<\/ul>\n
Mark to Market (M2M \u2013 Mark to Market)<\/h2>\n
Because the price in the futures market changes every day, your profit or loss also changes every day. Mark to Market or M2M calculates and keeps your same profit or loss at the end of the day so that at the end of the day you can know how much loss or profit you have made. M2M goes on as long as you stay in the futures contract. Let us understand this with an example.<\/p>\n
Suppose on 1st December 2014 at 11:30 you decided to buy Hindalco futures at \u20b9165. Its lot size is 2000. After 4 days i.e. on 4th December 2014 you square off your position at 2:15 and the price is \u20b9170. 10. In the calculation below, you will see how much you have benefited.<\/p>\n
purchase price = 165<\/p>\n
Selling price = 170.10<\/p>\n
Profit per share = 170.1-165 = 5.1<\/p>\n
Total profit = 2000 \u00d7 5.1<\/p>\n
= 10,200\/-<\/p>\n
But the deal was for four days. So every day its advantage or disadvantage was being noted in M2M. To calculate M2M, the closing price of the previous day is used.<\/p>\n
\n\n
\n Date<\/b><\/th>\n Closing Price<\/th>\n<\/tr>\n \n 1st Dec 2014<\/td>\n 168.3<\/td>\n<\/tr>\n \n 2nd Dec 2014<\/td>\n 172.4<\/td>\n<\/tr>\n \n 3rd Dec 2014<\/td>\n 171.6<\/td>\n<\/tr>\n \n 4th Dec 2014<\/td>\n 169.9<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n Let us understand on the basis of this table what happened in M2M every day in the last 4 days?<\/p>\n
The futures contract was bought at 11:30 on the first day when the price was \u20b9165. The price rose on the day of buying and the closing price stood at \u20b9168.3. That is, the profit of the day was \u20b9 168.3 – \u20b9 165 = Rs 3.3. Since the lot size here is 2000, the total profit will be 3.3 \u00d7 2000 = \u20b96600.<\/p>\n
Now the exchange will ensure that \u20b96600 is credited to your trading account through the broker by evening.<\/p>\n
But where is this money coming from?<\/p>\n
Money is coming from your counterparty. Meaning the exchange has ensured that the counterparty gives you \u20b96600 for his loss.<\/p>\n
But how does the exchange ensure that the counter party gives this money?<\/p>\n
For this it only uses the margin which was deposited at the very beginning of the transaction.<\/p>\n
Now you have to pay attention to one more important thing here \u2013 to keep the accounts correct, now your purchase price will not be \u20b9 165 but \u20b9 168 because this is the closing price of that day. You may ask why is this so? This is because any profit earned on that day has already been sent to your trading account as Mark to Market (M2M). It also means that your accounting till this day has been completed. The next day will be a new day. Hence the next day’s price of \u20b9168.3 will be considered as the opening price which was the previous day’s closing price.<\/p>\n
On the second day i.e. on the second day of the transaction, the futures closed at \u20b9 172.4 i.e. it was the close price. It means that on this day also you made profit. The profit per share for this day will be \u20b9172.4 \u2013 \u20b9168.3 = \u20b94.1 and the total profit is 2000\u00d74.1 = \u20b98800. Now this profit will also come in your trading account and now the price will be \u20b9 172.4.<\/p>\n
On the third day, the futures price closed at \u20b9 171.6 i.e. against the previous day’s close price, you are incurring a loss of \u20b9 1600 (172.4-171.6 = 0.8\u00d72000= 1600) on this day. This amount will also be directly withdrawn from your trading account and now the new price will be \u20b9171.6.<\/p>\n
On the 4th day you did not hold this position and you squared off your trade at \u20b9170.10 at 2.15 pm. That is, even on this day you did not gain but loss. \u20b9 1.5 (171.6 \u2013 170.1 = 1.5) and total loss of \u20b9 3000 (1.5 \u00d7 2000). Any price change after that will not affect your account as you have already squared off your position. By the end of the day, \u20b9 3000 will definitely be withdrawn from your trading account, which is your loss for that day.<\/p>\n
Putting all these transactions in a table see how the Mark to Market (M2M) keeps on changing.<\/p>\n
\n\n
\n Date<\/b><\/td>\n price for M2M\u00a0<\/b><\/td>\n closing price<\/strong><\/td>\n Day’s<\/b> M2M<\/b><\/td>\n<\/tr>\n \n 1st Dec 2014<\/td>\n 165<\/td>\n 168.3<\/td>\n + Rs.6,600\/-<\/td>\n<\/tr>\n \n 2nd Dec 2014<\/td>\n 168.3<\/td>\n 172.4<\/td>\n +Rs.8,200\/-<\/td>\n<\/tr>\n \n 3rd Dec 2014<\/td>\n 172.4<\/td>\n 171.6<\/td>\n -Rs.1,600\/-<\/td>\n<\/tr>\n \n 4th Dec 2014<\/td>\n 171.6 & 170.1<\/td>\n 169.9<\/td>\n \u2013 Rs.3,000\/-<\/td>\n<\/tr>\n \n Total<\/b><\/td>\n +Rs.10,200\/-<\/b><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n If you calculate it again, you will see that \u2013<\/p>\n
purchase price = 165<\/p>\n
selling price = 170.1<\/p>\n
Profit per share = (170.1 -165) = 5.1<\/p>\n
Total profit = 2000 \u00d7 5.1<\/p>\n
= Rs 10,200\/-<\/p>\n
So mark to market i.e. M2M is a method of daily accounting,<\/p>\n
In which money either enters or leaves your trading account depending on the change in the price of futures.
\nTo calculate the mark to market for each day, the closing price of the previous day is taken as the basis.<\/p>\nAfter all, what is the need for mark to market? Basically by paying the profit or loss amount every day through mark to market i.e. M2M, the exchange ensures that the risk of counterparty default in the market is minimized. This calculation from mark to market keeps on getting equal every day.<\/p>\n
Now back to the margins once again.<\/p>\n
Margins \u2013 Large Perspectives<\/h2>\n
Keeping in mind the mark to market, let’s look at the margin once. As we have discussed earlier that the margin that is deposited at the time of trading is called Initial Margin (IM) or Initial Margin. And it is a fixed percentage of the contract value. we also know<\/p>\n
Initial Margin (IM) = SPAN Margin + Exposure Margin<\/p>\n
As soon as you start any deal in the futures market, a lot of financial intermediaries ie financial intermediaries are engaged in the work, so that your every deal can be completed smoothly without any interruption. The two most important intermediaries are the exchange and the broker.<\/p>\n
Now if you default in your deal, it will affect both the broker and the exchange. Margin is used to protect both of them from any loss.<\/p>\n
The minimum margin or minimum margin fixed by the exchange is called span margin. After this, to avoid any loss in M2M, another amount is added as margin which is called exposure margin. Both these margins are decided by the exchange. That is why the initial margin has to be deposited for any futures deal. The entire initial margin (SPAN + exposure margin) is blocked by the exchange.<\/p>\n
The span margin is the more important of these two margins. If the SPAN margin amount is not on your trading account, you may be subject to a penalty. You need to have a span margin to hold your trade or to maintain your position. That’s why the span margin is sometimes called the maintenance margin.<\/p>\n
Now the question is, how is it decided that what should be the span margin for which stock? A method algorithm is used to calculate this margin every day. The volatility in that stock plays a very important role in deciding how much this margin will be. What is volatility, we will discuss in the next module. Now it is important to know that as volatility increases in a stock, so does its margin.<\/p>\n
Exposure margin acts as an additional margin. It is usually between 4 and 5% of the contract value.<\/p>\n
Now let’s look at a futures trade from a margin and M2M perspective.<\/p>\n
\n\n
\n Description<\/b><\/td>\n Explanation<\/b><\/td>\n<\/tr>\n \n Stock<\/td>\n HDFC Bank Limited<\/td>\n<\/tr>\n \n Type of trade<\/td>\n Long<\/td>\n<\/tr>\n \n buy date<\/td>\n 10th Dec 2014<\/td>\n<\/tr>\n \n buy price<\/td>\n Rs.938.7\/- per share<\/td>\n<\/tr>\n \n sale date<\/td>\n 19th Dec<\/td>\n<\/tr>\n \n sell price<\/td>\n Rs.955\/- per share<\/td>\n<\/tr>\n \n lot size<\/td>\n 250<\/td>\n<\/tr>\n \n contract value<\/td>\n 250*938.7 = Rs.234,675\/-<\/td>\n<\/tr>\n \n SPAN margin<\/td>\n 7.5% of CV = Rs.17,600\/-<\/td>\n<\/tr>\n \n exposure margin<\/td>\n 5.0% of CV = Rs.11,733\/-<\/td>\n<\/tr>\n \n IM\/ initial margin (SPAN + Exposure)<\/td>\n 17600 + 11733 = Rs.29,334\/-<\/td>\n<\/tr>\n \n Per-share P&L<\/td>\n per share Rs.16.3\/- (955 \u2013 938.7) profit<\/td>\n<\/tr>\n \n Total profit<\/td>\n 250 * 16.3 = Rs.4,075\/-<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n
![\"\"](\"https:\/\/gauravheera.com\/sharemarket\/wp-content\/uploads\/2021\/10\/m2m-explained.jpg\")
<\/a>