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What is Margin Money?
Margin is the amount of collateral either in form of cash or shares (as applicable) that a trader needs to trade in Futures or sell Options.
Margin money meaning
In the stock market margin money refers to:
- Initial Margin
- Maintenance Margin
- Variation margin
Initial margin meaning
Initial Margin refers to the minimum amount that a trader needs to keep in his/her Demat account to take a position in futures. Whether one is taking a long position or a short position, they have to keep the Initial Margin in their account. It is different for different shares.
For instance, to buy 1 lot of HDFC Bank futures currently trading at ₹2,692; a trader has to keep an initial margin of ₹152,185. This is 18.8% of its full contract value.The initial margin required to take a position in Indices like Nifty which is currently trading at 18,286 is ₹85,935. This is 9.4% of its full contract value. Initial margin requirement is different for different shares. However, the initial margin charged on indices is usually lesser as these are comparatively less risky. The initial margin percentage is also revised from time-to-time.
Maintenance Margin meaning
Maintenance margin refers to the minimum amount that a trader has to maintain in his/her account in order to continue holding an open position in the market at all points of time.
Let us understand with the help of an example. Let's assume that Reliance Industries futures are trading at ₹2,400. The contract value of 1 lot of Reliance Industries futures is ₹6 lakhs. This one was bought with the Initial Margin of 20%, i.e. ₹1,20,000. The maintenance margin for this is 10%.This means one must have ₹60,000 in his/her account at all times. If there is a fall in the price of Reliance Industries futures and a loss of ₹60,000 was incurred on this position.This means that the trader has lost ₹60,000 out of his Initial Margin of ₹1,20,000.
The trader is at his threshold of the maintenance margin. If the position falls further and the trader incurs a loss, the position will come below the Maintenance Margin. Here, the broker has 2 options:
- The broker might ‘square off’ your position at this point.
- The broker will send the trader a margin call.
Margin Call meaning
A margin call is a notice a stock-broker sends to a trader when their maintenance margin decreases below the safe level. A trader has to add surplus funds into his account on receiving a margin call to save their futures contracts from getting automatically squared off and a penalty being levied. Broker’s do not always send a margin call. It is the onus of the trader to monitor and ensure sufficient margin in the account at all times.
Variation margin refers to the surplus amount to be added into a trader's demat account on receiving a margin call. Variation margin is calculated as the difference between the initial margin and the cash available in the demat account on receiving a margin call.
The daily adjustment of profit or loss on the open position is known as Mark-to-Market. This adjustment does not mean that the open position is settled or squared off.
Let us understand this with the help of an example. A trader has purchased 1 Lot of Reliance Industries Futures when it was at ₹2,400. The lot size of Reliance Industries is 250.
- Day 1 closing: Reliance Industries futures prices shoot up by ₹20, so he makes a profit of ₹5,000. This amount will get credited to his/her account.
- Day 2 closing: Reliance Industries futures prices go up by ₹30, so he makes a profit of ₹7,500 on that day. This amount will also get credited to his/her account.
- Day 3 closing: Reliance Industries prices fall by ₹30, so he will incur a loss of ₹7,500 on that day. This amount will get debited from his/her account.
This is how Mark-to-Market is calculated on long positions on a daily basis.
Let's understand how it is also calculated on short positions with the help of an example of Tata Motors futures.
Mr. Singh has a short position on Tata Motors Futures which is trading at ₹300 with a lot size of 2,850.
- Day 1 closing: The price of Tata Motors Futures falls by ₹2. He will make a profit of ₹5,700. This amount will get credited to his account.
- Day 2 closing: The price of Tata Motors futures falls by ₹3. He will make a profit of ₹8,550.This amount will get credited to his account.
- Day 3 closing: There is a rise in the price of Tata Motors Futures by ₹3. He will incur a loss of ₹8,550.This amount will get debited from his account.
This is how Mark-to-Market works on Short Positions.
Points to remember about Mark-to-Market:
- Mark-to-Market has to be paid in cash.
- It does not mean that your position is being ‘closed out’. It is only being settled on a daily basis.
- A position will ‘close’ only when it is ‘squared off’ or settled at expiry.