- With a hedging strategy, you must establish and maintain a margin account (e.g., performance bond) with broker as insurance against defaulting on any loss.
- Amount required in this account varies from broker to broker.
- Initial Margin: Initial deposit of funds required to be deposited when purchasing a futures contract.
- Futures contracts are evaluated on a daily basis by your broker with all futures profits/losses being settled each day out of your margin account.
- Margin Call: You are required to add to your margin account when prices move against your position. What is considered a negative movement depends on whether one is a buyer or seller of a futures contract as explained below:
- Margin calls may bring the value of your margin account to the original initial margin level. Small loss allowed before margin calls.
- Maintenance Margin: The loss level which initiates a margin call.
- The following example illustrates changes in a margin account over a two week period:
Assume that you are a dairy farmer and sell 1 Class III futures
contract on the CME to hedge 200,000 lbs. of next month’s production.
The following example shows the margin account that needs to be
established and maintained. Assume the broker requires $300/contract
as an initial margin and establishes a maintenance margin
of $200/contract. Remember the CME Class III contract is for 2,000 cwt.
|Example of Margin Account Changes|
|Date||Futures Transaction||Price ($/cwt)||Contract Value Change||Account Balance||Margin Call|
|Oct. 5||Sell Oct. Class III||13.50||
|Oct. 6||Hold||13.40||-$200||$300 – (-$200) = $500||$0|
|Oct. 7||Hold||13.45||+$100||$500 – $100 = $400||$0|
|Oct. 8||Hold||13.55||+$200||$400 – $200 = $200||$0|
|Oct. 9||Hold||13.60||+$100||$200 – $100 = $100||$200|
|Oct. 12||Hold||13.55||-$100||$300 – (-$100) = $400||$0|
|Continue with account until either you lift your hedge or it is cash settled|