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How To Margin Commodity Futures

How to margin commodity futures is another installment of our series of How To Tutorials. When you read this mini-course on how to margin commodity futures you'll easily demystify the maintenance of a commodity futures account and understand how and why a commodity margin call is created and subsequently disposed of. But first, let's get you up to speed with…

A "Quick and Dirty" Commodity Futures Glossary

Futures Contract - A contract to buy or sell a set quantity of a commodity, at a set price, on a future date.

Initial/Original Margin Requirement - The funds required in a commodity account when a position either long (bought) or sold (short) is established.

Variation/Maintenance Margin Requirement - The equity point at which a margin call is issued to bring the account back to the initial/original margin level.

Initial/Original Margin Call - A margin call that is issued when a new position is taken.

Variation/Maintenance Margin Call - A margin call requiring enough funds to bring the account back to its original margin level.

CBOT - Chicago Board of Trade. Domestic commodity futures exchange.

Equity - The account net worth which equals the funds deposited plus the unrealized gains or losses on commodity contracts (positions) in the account at any given time.

Settlement/Closing Price - The daily price that is set at the end of every trading day. This price is used as the basis for determining account equity.

T-Bond Contract - CBOT contract for a $100,000 T-Bond. Point value is $31.25 per tick and one full point equals 32/32nds or $1000. Initial Margin: $2700 Maintenance Margin: $2000. (Margin requirement is for educational purposes and can change at any time.)

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Commodity Futures Price Ticker

Check daily commodity futures prices with this commodity futures price ticker located on the right side of this page. Courtesy of thefinancials.com

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Commodity Futures Margin Tutorial

Let's establish a hypothetical commodity position

The news hits the street. The Fed just lowered interest rates and feels the softening economy might warrant further cuts to avoid a recession. The economic guru in you thinks this will be the case and you quickly establish a position in the CBOT T-Bond market and buy two December contracts at a price of 9500. You feel that interest rates will fall in the future causing a rise in the price of your T-bond contracts and a hefty profit. The settlement price at the end of the day is 9510.

The following day you have an initial margin call

Based on the settlement price of 9510 you have equity of $625. That's the difference of your trade price of 9500 and the settlement price of 9510. The calculation looks like this: 10 X $31.25 = $312.50 X 2 contracts = $625. Your broker calls you and issues you an initial margin call of $5400. $5400 is derived from your position of 2 T-bond contracts with an initial margin requirement of $2700 per contract.

The calculation looks like this: $2700 X 2 = $5400. If the funds were deposited on that day your account would have a total equity of $6025. That equals the initial margin deposit of $5400 + unrealized gain of $625.

On the same day the commerce department issues the new unemployment figures which show a huge drop in the unemployment rate from 4.7 to 4.1. The bond market tanks and the price for your December contract settles at 9400, down 1 10/32. You lose $2625 for the day.

The calculation looks like this: 42 X $31.25 = 1312.50 X 2 contracts = $2625. Remember that 1 full point is equal to 32/32nds plus an additional 10 points for a total of 42/32nds. Your total equity has fallen to $3400. The calculation looks like this: $6025 - $2625 = $3400.



The following day you receive a maintenance margin call

Because the change in the settlement price reduced your total equity to $3400, you receive a margin call of $2000. Your maintenance margin requirement is $4000. Once your maintenance margin level is breached, you must bring the account back up to full initial margin of $5400 again. The calculation looks like this $5400 - $3400 = $2000.

You wire transfer the $2000 to your account to meet your margin call the same day and because of a bearish GNP forecast, the December T-Bond contract rises and closes at 9416. You have a gain for the day of $1000. The calculation looks like this: 16 X $31.25 = 500 X 2 contracts = $1000. The margin deposit plus the unrealized gain puts your account equity at $6400 for the day.

The next day…Now you can take some money off the table

Your total account equity is $6400 your margin requirement is $5400. You can request the excess funds of $1000 be sent to your bank account. This is called a payout. The calculation looks like this: $6400 - $5400 = $1000.

That's all there is to it. Each day your position is recalculated based on the settlement price. Your equity is determined and your margin call or payout is calculated. This process is repeated until your margin requirement changes because of adding or liquidating positions.

How can you satisfy margin calls

There are a number of ways to meet margin calls. Everybody knows you can add funds to your account, but you can also put T-Bills into your account as collateral or liquidate positions which will reduce your margin requirements.

That's it. Now you know how to margin a commodity futures account. It gets a little more complicated with multiple commodities, spread positions and multiple Exchanges, but unless you decide to trade commodity options too, this will take the mystery out of where all that money goes on a daily basis. Maybe we'll follow up on this tutorial and take a look at how to margin commodity options.

By: Rick Contrata

Rick has been in the commodity industry for almost 25 years, holding management and executive positions In commodity operations and margins with ACLI, Bear Stearns and DLJ. He also owns an Internet marketing, consulting and copywriting business.

Related articles:
Margin Commodity Options How To, Commodity Options Margin Tutorial

Commodity Hedging, Hedging Risk with a Commodity Hedging Strategy

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