Leverage and Margin in Futures

Many market participants prefer trading in futures rather than directly in equities. Why? Because futures offer two major advantages: leverage and risk management. In this chapter, we break down the concept of leverage, how margin plays into it, and how to manage both effectively while trading via m.Stock. 

Understanding Leverage and Margin: The Basic Equation 

Unlike buying stocks outright, trading in futures does not require full upfront payment of the contract value. Instead, traders only need to deposit a portion of the total contract value, this is referred to as the margin. 

Let’s consider a simplified example: 
Suppose a futures contract is based on a stock priced at ₹1,000, with a lot size of 1,000 shares. While the total contract value is ₹10 lakh, you may only be required to deposit 20%–30% of that amount as margin. 

So, if the margin is set at 20%, you gain 5x exposure compared to trading in equity, meaning a 1% move in the underlying asset results in a 5% gain or loss. While this leverage can significantly enhance profits, it also magnifies losses. 

Even small price fluctuations can have a compounded impact due to leverage. Hence, to safeguard market integrity, exchanges mandate margin top-ups when the trader’s position suffers a loss close to the margin limit. Failure to comply may lead to automatic liquidation of the position. 

Margins in Equities vs. Futures 

It’s critical to understand that margin means different things in equity and futures markets: 

• In equity trading, margin often refers to borrowing up to 50% of the purchase value to acquire stocks, known as margin buying. 

• In futures, the margin is not a loan or down payment. It is the minimum balance a trader must maintain in their account to hold a position. You do not take ownership of the underlying asset. 

Types of Margins in Futures Trading 

Initial Margin 

The initial margin is the entry-level amount defined by the exchange for opening a futures position. Your broker may also require an additional buffer. 

Example: 
For an oil futures contract valued at ₹32,500 (say, ₹6.50 x 5,000 units), with a 5% initial margin, you’d only need to deposit ₹1,700. The actual requirement may go up depending on brokerage fees. 

Maintenance Margin 

The maintenance margin is the minimum balance you must maintain in your account throughout the trade. If your margin balance falls below this level due to price movement, you’ll receive a margin call and must top up your account to restore it to the initial level. 

Example: 
If your initial margin is ₹10,000 and the maintenance margin is ₹7,000, and your position value drops by ₹3,500, you’ll need to add ₹3,500 to stay in the trade, or close the position to avoid further loss. 

Key Features of Margin in Futures 

1. Lower Margin Percentage: Futures margin typically ranges from 3% to 12% of the contract value, compared to 50% for margin buying in equities. 

2. Variable Requirements: Margins can increase in volatile markets and decrease during stable periods based on clearing-house assessments. 

3. Automatic Adjustments: If your balance drops below the maintenance margin, your position may be reduced or liquidated. 

4. Exchange-Set Rates: Futures margin levels are decided by exchanges, not brokers. Brokers may, however, set a higher requirement to manage risk. 

5. Counterparty Protection: Margin allows the exchange to act as a counterparty, ensuring smooth settlement and maintaining anonymity between buyer and seller. 

Managing Leverage Risk While Trading 

Always Use Stop Losses 

Stop-loss is your first line of defense. Even if the price might eventually recover, your goal as a leveraged trader is capital preservation, not wishful thinking. Cut losses quickly to prevent margin wipe-outs. 

Book Profits Periodically 

Take profits regularly to protect your liquidity and build a stronger corpus. This gives you greater flexibility for future trades and helps reduce risk. 

Diversify to Avoid Concentration Risk 

Avoid placing all your futures trades in one sector. For example, if all your positions are interest-rate-sensitive, a rate hike can hurt all of them simultaneously. Spread out your trades to cushion against adverse news flows. 

Avoid Averaging Down in Leverage 

Doubling down on a losing futures trade can dangerously increase exposure. Unlike equity investments, averaging down in leveraged trades can amplify your losses rapidly. 

Conclusion 

• The margin is the minimum capital you need to trade futures. 

• It provides leverage, allowing you to trade with more exposure than your actual capital. 

• Leverage magnifies both gains and losses, making risk management critical to long-term success.