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Benefits of Futures: Margin

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You've probably heard the term margin before but do you know what margin means? Because when we talk about security's margin and futures margin, we're really talking about two very different things and understanding the difference is important in the securities world. Margin is the money you borrow as a partial down payment up to 50% of the purchase price to buy and own a stock bond or ETF. This practice is often referred to as buying on margin.

So how is futures margin different?  Futures margin is the amount of money that you must deposit and keep on hand with your broker when you open a futures position. It's not a down payment and you don't own the underlying commodity.

The good news is that futures margin generally represents a smaller percentage of the notional value of the contract typically 3 to 12 percent per futures contract as opposed to up to 50% of the face value of securities purchased on margin when markets are changing rapidly and daily price moves become more volatile. Market conditions and the clearinghouses margin methodology may result in higher margin requirements to account for increased risk when market conditions and the margin methodology warrant margin requirements may be reduced. Now let's look at some types of futures margin.

Initial margin is the amount of funds required by the exchange to initiate a futures position. While the exchange sets the margin amount, your broker may be required to collect additional funds for deposit. The other type is maintenance margin. Maintenance margin is the minimum amount that must be maintained at any given time in your account.  If the funds in your account drop below this level a few things can happen:  

You may receive a margin call where you will be required to add more funds immediately to bring the account back up to the initial margin level.  If you don't or can't meet the margin call you may be able to reduce your position in accordance with the amount of funds remaining in your account. Or your position may be liquidated automatically once it drops below the maintenance margin level. A small change in a futures price can translate into a huge gain or loss, so understanding how a futures margin works is essential to maximize the capital efficiencies that futures afford you.

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