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Derivatives 101 Prepared by: Stephanie Kimani
Principal:
This identifies each client/member based on a unique code. With this code you are able to have a
brief overview of the clients’ details.
Margin balance:
This is the minimum amount of money required in your client’s account so as to be able to trade a
particular futures contract. The margin varies from market to market and differs if you are doing a
day trade versus a position trade.
The purpose of this minimum amount is to make sure that the client has money in their account to
pay for possible losses on that trade. The unique characteristics about futures trading margin is a
relatively low amount is required and the fact that you do not have to pay interest on the
remaining margin balance.
When buying equities, a margin is the ability to trade a stock with e.g. 50% margin where you
are able to buy Ksh 100,000 worth of a stock with only Ksh 50,000 in your account while the
remaining balance you are required to pay interest on it as you are borrowing from your
brokerage firm.
With futures margins the client only needs a small percentage of the contract value on hand with
the broker and they would not have to pay interest on the remaining balance. For example, if you
are buying a single stock future for Ksh 15 per contract, each contract has a nominal amount of
Ksh 100 and are purchasing 1,000 contracts then the total contract value would be Ksh
1,500,000. However, if only 5% margin (initial margin) is required then you would only need Ksh
75,000 in your margin account.
To note is that if there is a small move in the futures price then this could equate to a large move
relative to the margin balance in your account. This is good if the client who is making a profit but
detrimental to those making a loss.
Important margins:
There are two important margins a dealer needs to be aware of at all times. That is the initial
margin and the maintenance margin. The initial margin is the amount needed initially to
place an order. In our previous example, we took the initial margin as 5% of the total contract
value. (The example assumed that there is no previous day’s margin balance)
The maintenance margin is usually between 70 - 80% of the initial margin and is the amount of
money the client is required to maintain in their bank account after the position is put.
In the event the account balance falls below the maintenance margin, then the client will receive a
margin call which alerts the client to either deposit more money to their account so as to bring it
back to/above the initial margin requirement so as to keep the position open or that the clients
position may be liquidated or closed out to avoid further potential losses.
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Derivatives 101 Prepared by: Stephanie Kimani
For example:
Starting Account Balance = Ksh 250,000
Total Contract Value (based on previous example) = Ksh 1,500,000
Initial Margin required (5% of contract value) = Ksh 75,000
Maintenance Margin required (75% of Initial Margin) = Ksh 56,250
If the account balance falls below the maintenance margin then the client receives a margin call
from their broker.
New Account Balance = Ksh 50,000
Margin Call
Option 1: Variation Margin: Ksh 75,000 – Ksh 50,000 = Ksh 25,000
Option 2: Either close out some or all of your open positions to meet the margin call.
Margin Requirement:
This is the initial margin requirement stated previously as the initial margin which a small
percentage of the total contract value.
Variation Margin:
Minimum amount needed to bring back the account to initial margin
For example:
Profit/Loss: This is based on either the trade or the position. You compute this as follow:
Price traded at = Ksh 15
Last traded price = Ksh 12
Number of contracts = 1000
Profit/Loss: (Ksh 15 – Ksh 12)*1000 = Ksh 3,000
NB: If long then multiply with a +ve quantity, it short multiply with a –ve quantity.
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Derivatives 101 Prepared by: Stephanie Kimani
Exposure:
This is the total amount you could lose on every single one of your positions. It is based on the
outstanding number of shares and doesn’t look at it from a margin point of view but the total
outstanding value of the contract. It is computed as follows
Exposure = last traded price x nominal amount x quantity
NB: If long then multiply with a +ve quantity, it short multiply with a –ve quantity.
Settlement amount:
This is the projected settlement amount that is computed from the summation of the margin
movement and the projected profit/loss.
NB: settlement is based on profit/loss from an order being executed and position movements.
For more information on this, kindly contact me on my direct line 0711047125 or via email
kimania@aibcapital.com