WHAT IS MARK TO MARKET MARGIN (M2M) IN FUTURES and OPTIONS?
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Published on 20 February 2023
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One of the key risk management concepts for futures positions is the opening margin charged to clients trading in the futures sector. The starting margin consists of the Exposure margin and SPAN margin, which is determined daily by the exchange. This is a pre-blocked amount in your account.
But what if the next day the price moves in the opposite direction? In other words, what happens if the price goes down when you go long or goes up when you go short?
There is another type of margin called M2M or Mark-to-Margin for this. It is calculated daily and is credited or debited to your margin account. So, what is the market margin of futures, and what does MTM mean in trading? And how to calculate Mark-to-Margin when it comes to futures and options.
But before we get to the Mark-to-Margin, let's first understand the basic margin in the share market, the initial margin.
Understanding the Shades of Initial Margin
As mentioned earlier, the initial or opening margin consists of the Exposure margin and SPAN margin. The SPAN margin is the default margin calculated using the value at risk (VAR) method. VAR considers the maximum loss a stock can have in a day hinged on historical odds.
SPAN margin collection is mandatory under NSE and SEBI rules and regulations. Risk margin is an optional extra margin, but most brokers charge risk margin as an extra safety buffer.
Assuming that you have taken a long position in the Punjab National Bank Futures and your Exposure margin is 6.23%, your SPAN margin is 10.96%, your total initial margin is 17.19% (summed up).
Initial Margin = Exposure Margin + SPAN Margin
Note, Initial Margin = % of Your Contract Value.
And, Your Contract Value = Future Prices * Size of the Lot.
The size is fixed, but when it comes to futures, the price changes daily. This means that the margin also changes every day.
What is Mark-to-Market (M2M) Margin?
One of the futures market characteristics is the daily M2M (mark-to-market) rates on every contract. As a result, the closing daily settlement rate for the futures is the same for all. Mark-to-Market was the distinguishing difference between forwarding and futures after the 2007-2008 financial crisis until regulatory reforms were introduced.
Before these reforms, most over-the-counter forwards and swaps didn't have official regular settlement prices, so clients were completely unaware of daily movements except as elucidated in the theoretical pricing model.
The futures market has an official regular settlement rate set by the exchange. Contracts might have slightly different daily and closing settlement formulas set by the exchange, but the methodology is completely disclosed in the contract specification and the exchange's rulebook.
To determine the position value of a futures contract, use the following formula:
Changes in the value of futures contracts = Same day futures contract price – Previous day’s closing price
P&L for the day = Futures contract value price change * Number of lots
Total P&L = Sum of all daily P&Ls before holding a futures contract position.
Here’s an M2M (Mark-to-Market) example for better understanding:
Buy price - ₹100
Sell price - ₹102
Lot Size - ₹9500
Trade Profit - ₹102-₹100 = ₹2
Total Profit: ₹9500*₹2 = ₹19,000
Things to Keep in Mind
Mark-to-Market is only calculated for future contracts and not for equity stocks of options.
The Mark-to-Market is populated in real-time but is updated in the registry after the day ends.
Mark-to-Market (M2M) realised P&L for a closed position is not reflected in the trading platform in the day but is updated in the console book at the day's end. Further, it is updated on the trading platform early the next day.
If your current position is in loss and you don't have enough account balance, the position gets squared, and a margin penalty is levied.
If the security does not trade on a specific date, Mark-to-Market last available final price is considered.
Mark-to-Market losses on positions are shown as unrealised gains in the trading platform until liquidated.
The Bottom Line
Mark-to-market (M2M) enforces the routine discipline of exchanging gains and losses between open futures positions, except for losses or carry-overs of gains that could put the clearinghouse at risk. Having a daily margin closing settlement means that all open positions are treated equally. By posting these daily settlement values, the exchange provides an excellent service to speculative and commercial users in the futures market and the underlying market that accepts prices. Know more about Futures Pricing & How to calculate it?
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Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
What Do You Mean by Leverage & Payoff in Futures & Options?
Derivatives have built-in financial leverage, the source of power that underlies derivatives trading. Leverage encourages investors to invest money and create wealth in the finance world. Appropriate use of financial leverage can be a means of increasing wealth. Futures trading uses leverage extensively to create wealth for investors.
Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
What Do You Mean by Leverage & Payoff in Futures & Options?
Derivatives have built-in financial leverage, the source of power that underlies derivatives trading. Leverage encourages investors to invest money and create wealth in the finance world. Appropriate use of financial leverage can be a means of increasing wealth. Futures trading uses leverage extensively to create wealth for investors.
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