One of the most challenging aspects to understand around futures markets is the mechanics of margin and/or margin calls. It’s also something that has hit many hedgers in the pocketbook, but it doesn’t have to catch them off guard.
This is an edited version of an article by private market advisor Nevil Speer that he wrote for Beef magazine. Beef has graciously allowed the use of these articles here.
ESSENTIAL ASSUMPTIONS
This article highlights an example of margin calls during the past several months for parties on each side of Nov feeder cattle futures. Several starting assumptions are important here.
First, assume the contract was initiated at $161 per cwt (making the total contract value of a 50,000-pound equivalent at $80,500). Second, also assume the contract closed on June 24 at $133 per cwt (with a contract value of $66,500 – a net decline of $14,000 from the starting point).
Here enters the aspect of margin: it represents a small portion of total contract value but represents a trader’s “skin in the game.” And as any seasoned trader will let you know, those margin calls can get very painful if you’re on the wrong side of the market.
KEY CONCEPTS
Several key concepts are important to distinguish here:
–Initial margin: the initial amount of up-front money required to buy and/or sell a futures contract (for this example, initial margin was $3,100). This can vary from broker to broker depending on the contract and the customer.
–Maintenance margin: the minimum amount a trader’s account must carry ties to the contract position. This amount is established by the CME Group. Currently, the feeder cattle contract maintenance margin equals $2,800.
–Margin calls: when maintenance margin falls below the minimum threshold (in this example, $2,800), margin call represents the amount of money required to re-establish the margin account back to the initial margin level.
APPLICATION
Ok, assume a trader went long Nov feeder cattle on April 19, 2019, at $161. Since then, the market has worked against his position. His purchase has lost $14,000 in total value – and he subsequently received 13 margin calls in the total amount of $14,000 to keep him in the game.
Meanwhile, if he were short the contract, the market has moved in his favor. He’s experienced only one margin call for a total of $462.50.
At the end of this time period, margin accounts for the long and short trader would total $3,100 and $17,562.50, respectively. The long trader has deposited $14,000 in margin calls and has only $3,100 in his account.
Meanwhile, the short trader has deposited the initial $3,100 plus one margin call of $462.50 (which the market gave back over time) – hence that short account is up the same amount the long account is down: $14,000.
Therein lies the fundamental principle of futures trading – for every winner, there’s a loser – and for every loser, there’s a winner – a perfect zero-sum game.
CATTLE, BEEF RECAP
Cash cattle trade last week was at $100 to $103 per cwt on a live basis, $2 to $5 lower than the previous week. Dressed-basis trade was at $160 to $167, $4 to $10 lower.
The USDA choice cutout Tuesday was down $1.57 per cwt at $225.38, while select was off $0.94 at $200.98. The choice/select spread narrowed to $24.40 from $25.03 with 98 loads of fabricated product sold into the spot market.
The CME Feeder Cattle index for the seven days ended Monday was $136.44 per cwt, down $1.33 from the previous day. This compares with Tuesday’s Sep contract settlement of $133.90, up $1.07.