Chapter six, margin. Margin in the futures industry is established by the exchanges. Now note that the exchanges establish both the original or initial margin which is what you have to deposit when you initially take the position and the maintenance margin requirement which tells you when you'll get a call for more money. Now a couple of nuances with margin that they might ask. Notice on the left hand side, margin is the same whether you go long or short the position. So if margin, for example, is 30 cents a bushel, then it's 30 cents a bushel whether you're going long the contract or short the contract. Know that hedger margin is sometimes lower than speculators margin. Why? Because remember when you hedge, you have an opposite position in the cash market to your futures position. So if you're making on one, you're losing on the other. So if you're losing on one, you're making on the other. And notice they offset each other. So there's really less risk. That's the whole concept of hedging. Also, hedges are in better position to eventually make or take delivery of the commodity if they need to do so. So margin established by the exchanges the same whether you go long or short, but hedger margin is often lower than speculator margin. Now when you see margin there'll be two types of margin as we said the initial margin requirement is what you have to deposit to initially establish the position sometimes also called original margin. Then there's a maintenance margin requirement. That's what you need to maintain to keep the position. If your equity falls below the maintenance margin requirement, then you get a call to bring the equity back to the original margin requirement. And we'll look at that as we go along. So when you initially take the position, you put up initial margin. The position then moves either in your favor or against you. If it moves in your favor, the equity in your margin account goes up. But if it moves against you, the equity in your account goes down. The equity is calculated based on the daily settlement value of the contract. Now, the settlement value is where it ends the day. But be careful if you see a question that says true or false, the settlement value is always the last trade. That statement would actually be false. It's not always the last trade. Now, if equity falls below the maintenance level, then the client is required to bring equity back to initial margin. Not just back to maintenance, but back to original or initial margin. Now, how do we actually calculate the equity in the client's account? Here we could see that the total equity equals the account cash balance plus or minus the open trade equity. What does this formula mean? Well, we see the total equity in a position is equal to the money deposited net of withdrawals. This is referred to as the account cash balance. So, it's what you've deposited into the account that you have not withdrawn. But then we said they marked you to the market based on the settlement value. What we have is our gain or loss to date here. That is sometimes referred to as open trade equity. All that means is what are you up or down on the position since you established it. Now the account cash balance plus or minus the gain or losses to date is referred to as your total equity. The cash deposit could be your initial margin requirement, but it also could be additional deposits that you had to make because you fell below maintenance. And again, the open trade equity is calculated daily based on the contract's settlement price. Let's take our first look at a number example because it's really looking at the numbers when this becomes second nature. Let's say that wheat futures contracts have an initial margin requirement of 80 cents per bushel and a maintenance margin requirement of 60 cents a bushel. And what you'll generally find is that maintenance requirements are usually about 75% of the initial margin requirement. The contract size is 5,000 bushels. And remember wheat, one of the grains is one of the ones you have to know. Though I would expect you to know that there's 5,000 bushels of wheat in a contract here. Here they tell us the customer goes along one Mayw wheat contract when the price is $6 per bushel. So notice we're putting up 80 cents a bushel even though the contract is worth $6 per bushel. Wheat is worth $6 a bushel. So notice we are controlling $6 per bushel for a deposit of 80 cents per bushel. We are getting a lot of leverage. margin provides a lot of leverage in futures. What that means is for a small deposit, you're controlling a much bigger position. That's what results in big profits and losses on a percentage basis that you make when you trade futures because you're controlling a lot of a commodity for a small deposit. Generally, you'll see on the test that the margin requirement generally falls about 5 to 15% of the total contract value. And here you could see for 80 cents a bushel, we're controlling something that's worth $6 per bushel. So, first question, what is our initial margin requirement? Well, we're putting up 80 cents a bushel times 5,000 bushels in a contract. That means we're depositing $4,000 to establish this position. And that would be the same deposit whether we go long or short. So our account cash balance up to this date is $4,000. That's what we deposited. Our open trade equity, remember that's nothing more than just your gain or loss to date. Well, so far the contract hasn't moved, so we don't have any gain or loss. So our equity in the account is $4,000. Now, let's say that May wheat then drops to $5.90 a bushel. What would our equity now be? Well, if we look back at the original premise, the customer goes long one May wheat contract at $6. If it drops to 590, how have we done? We've lost 10 cents to date. So, we've lost money. Our equity has dropped to what? Well, our account cash balance is 4,000. That's what we've deposited. Now, we have a 10 cent loss times 5,000 bushels. So, we've lost $500. So, our remaining equity, $3500. Does that result in a call? Well, now we have to look at what's our maintenance. Our maintenance is 60 cents a bushel times 5,000 bushels. That gives us a maintenance requirement of $3,000. So if we drop below maintenance, then we'll get a call to bring back to initial. But we have not dropped below maintenance of $3,000. 60 times 5,000 bushels. So there's no call. But also know that you can't withdraw money from this account because you can only withdraw money if your equity is above initial margin requirement. So, we get no call because we're not below maintenance, but we can't withdraw money from the account because we're not above the initial requirement. Now, a very quick way that you could see that we got no call before we even do the math. If you look at the initial margin requirement of 80 cents, compare it to the maintenance requirement of 60 cents, notice that difference is 20 cents. That will show you how much you can lose before you'd get a call. So, we would get a call if we lost more than 20 cents. We could lose up to 20 cents without getting a call. Notice so far we've lost only 10 cents. Notice we got no call. But let's take it down to the next row. Let's say that Maywe drops to 575. What's our equity now? Well, notice how we could already see we're going going to get a call. Why? Because now we've lost 25 cents per bushel and we know our tolerance is only 20 cents a bushel. So we already know that this results in a call. Well, what is our remaining equity in the account? Well, our account cash balance is we've put up $4,000, but now we've lost 25 times 5,000 bushels, which we means we've lost $1,250. So notice our equity is now $2750. So now that is below the $3,000 maintenance requirement. 60 cents times 5,000 bushels gives us a maintenance requirement of $3,000. So now we get a call. Very important to know how much that call will be for to bring it back to initial. Not just to bring to maintenance, but to bring it back up to initial. So, the call is for $1,250 that we have to additionally deposit into our account. And notice how that brings our equity back up. Now, we've deposited $4,000 when we did the trade, and now we had to deposit another 1250. So, we've deposited 5250. To date, we've lost $1250. Our equity was brought back up to $4,000. Now, let's say that wheat turns back around and goes back up to 595. What would our equity now be? Well, we've put up 5250. We are now down only a nickel times 5,000 bushels. 5 cents times 5,000 bushels means we're down $250 on the trade to date. So, notice 5250 minus the 250, our equity is now $5,000. Now can we withdraw money from this account? The answer is yes because our equity now is above initial. So equity above the initial margin requirement may be withdrawn. Now they might ask you a term. Some traders will use that excess equity they have as margin to establish additional positions in this contract. know that that is sometimes referred to as pyramiding. As pyramiding when you use the excess equity to create new positions, it's sometimes referred to as pyramiding. Let's take a look at another example. Let's say that gold futures have an initial margin requirement of $70 per ounce, a maintenance requirement of $50 an ounce, and a contract size of 100 ounces. The customer shorts one December gold contract when the price is $1,400. And again, notice for $70 per ounce, we're controlling something that's worth $1,400 an ounce. So again, that's that leverage. We're controlling a much larger position. The full position is worth $1,400 times a 100 ounces. That's the value of the full contract. So, first question, how much do we have to initially put up to establish this position? Well, we have to put up $70 per ounce times 100 ounces. So, we have to put up $7,000. Our cash balance is the $7,000 we put up. Our open trade equity, and again, that just means what's your gain or loss to date? We haven't made or lost anything yet. So, our equity is $7,000. Well, what happens if December gold were to rally up to $1425? What would be your equity in the account if that were to happen? Feel free to pause the video if you want to try it on your own before we do it together. Okay. If gold rallied up to 1425, well, we still put up $7,000 to establish the position. That was that $70 an ounce times 100 ounces. But now, what have we made or lost? Well, the thing first thing to be careful about is when it moves, is that good or bad for us? So, let's take a look at what we did. Did we go long or short? Customer shorts one December gold contract. So, if the market rallies, we have a loss of $25 an ounce. Times 100 ounces, we've lost $2500. So, our equity is now 4500. Does that result in a call? Well, notice we lost more than the difference between original and maintenance. Original is $70 an ounce. Maintenance is $50 an ounce. That's a $20 difference. We've lost $25. So, I know that this results in a call. Why? Because we've dropped below maintenance. What's maintenance? $50 an ounce times 100 ounces means maintenance is $5,000. We've dropped to 4500. We're below maintenance. So, we get a call. For how much? To bring it back to initial or to just bring it up to maintenance. Remember, the call is to bring it all the way back to initial. So, we would get a call to deposit $2500 to bring our equity back to $7,000. So, now how much have we put up in total? $7,000 initially plus 2500 we just put up as a maintenance requirement. So, we've deposited 9500. How have we done to date? The gain or loss to date, we're down 2500. Notice we brought our equity back up to $7,000. Now, let's take a look at activity number 14. Again, feel free to pause the video and try it on your own before we do it together. Okay, let's take a look at how you did. A client shorts five June S&P 500 futures contracts at 1305.5. The initial margin on the S&P 500 futures is $25,000 per contract. And it has a multiplier, that's the contract size, of $250 per point. So each point that you make or lose is worth $250. If the June S&P 500 contract settles at $1295.5, what is the equity in the customer's account? So what are we calculating here? Well, we initially do this trade and we have to put up that initial margin requirement. We then make or lose money. They tell us here that the market moved to 1295.5. So, we're either up or down money. We would either add the gain or subtract the loss from that equity to figure out our new equity. If you did all this correctly, you would get $137,500. Let's see how we did that. We initially go short at 1305.5. We go short five contracts. Notice the market then drops to 1295.5. So the first question you really have to ask yourself is that good or bad for us? Well, since we're short and the market dropped, that is good for us. How much do we make? We shorted at 1305.5. It's now at 1295.5. we could buy it back for if we were to close out the position. So, we are up 10 points. How much is each point worth? Well, they tell us the multiplier. That's like the contract size for an index futures. The multiplier is $250 per point. We've made 10 points times 250 per point. We're up $2,500 per contract. So, what is our equity per contract? Well, we initially put up $25,000 per contract. That's the initial margin requirement, but we just calculated we made $2500 per contract. So, we have equity of $27,500 per contract. Multiply that by five contracts, which they tell us we shorted, and our equity is now [Music] $137,500. Now, some people do like to do this slightly differently. They figure out the entire initial margin requirement, then would add to that the entire profit on the five contracts. So they would say we initially put up $25,000 per contract. We did five contracts, so we initially put up $125,000. Add to that the profit 2500 per contract times five contracts is a profit of 12,500 added to the 125,000 initial margin requirement gives us the same $137,500. That concludes margin. I strongly recommend that you create a custom exam on this. Some people have a little bit of trouble with margin calculations. So, create a custom exam, practice some margin calculations right here since we just went over it. What's next? We'll look at long and short speculators and calculating profits and losses.