Futures trading Margin and Mark-to-Market Explained: How Daily Settlement Works

1. What is Margin in Futures Trading?

Margin is the amount of money you have to have with your broker in order to open or maintain a futures position.

Futures are exposed to a much larger contract value than the amount of margin that's actually deposited so margin is there to manage the risk of loss.

For instance, if you have a futures contract of ₹5 lakh in value you may only be required to put down a fraction of that as margin to take the position. The amount of margin required will vary depending on the contract, the market and the margin requirements in force.

Margin is not the maximum amount you can lose. If the market moves against you, your losses could in fact be greater than the initial margin you put down.

2. Types of Margin in Futures Trading

Different margins will apply when trading futures.

Initial margin is the amount required to open a futures position. In the equity derivatives segment, exchanges use risk-based margin systems, including SPAN, to calculate the required margin.

Extreme Loss Margin (ELM) is an additional margin collected to account for potential losses under extreme market movements.

Mark-to-market margin relates to the daily profit or loss generated by an open futures position. If a position incurs a loss, the trader may need to pay the amount as part of daily settlement.

These margins have very different functions. The initial and extreme loss margins are there to manage risk prior to and during the life of a position. The MTM settlement is the P&L that results from the daily price movements.

3. What is Mark-to-Market (MTM)?

Mark to market is the process of working out the daily P&L on an open futures position using the daily settlement price.

At the end of each trading day the exchange will establish a settlement price for the futures contract. The difference between the prior settlement price and the current settlement price is then used to calculate the day's profit or loss.

The amount is settled via the clearing system. On a daily basis the open position is effectively reset to the new settlement price for the purposes of the next day's calculation.

This means that profits and losses are not simply accumulated until the contract expires. They are settled daily.

4. How daily settlement works: A simple example

Suppose a trader buys one futures contract at ₹1,000 (lot size of 100).

The total contract value is:

₹1,000 × 100 = ₹1,00,000

Assume the trader puts in ₹15,000 as margin. That's a hypothetical amount, not the actual margin that would be required for a particular contract.

By end of first trading day, the futures settlement price is up to ₹1,020.

The daily profit is:

₹20 × 100 = ₹2,000

The Rs2000 profit is credited via the daily settlement.

On the following day the settlement price falls from ₹1,020 to ₹990.

The day’s loss is:

₹30 × 100 = ₹3,000

This loss is settled via the clearing system and will therefore reduce the funds available in the trading account.

Notice that the second day’s loss is calculated from the previous settlement price of ₹1,020, not the original entry price of ₹1,000.

5. What happens when a Futures Position makes a loss?

If the market moves against a trader's position the daily MTM loss can create a payment obligation.

For example if the trader takes a ₹5,000 loss that has to be settled as per requirement. The trader may be required to add funds to maintain the position and meet the applicable margin requirements.

If there aren't sufficient funds available the broker may issue a margin call or take action pursuant to its policies and the relevant rules (which could include reducing or closing the position).

That's why having extra funds beyond your initial margin can be important. A futures position can easily see several days of losses in a row prior to your intended exit or prior to contract expiry.

6. Why Margin and MTM matter to traders

Margin and MTM are linked, but they are not the same.

Margin is the amount required to support the position. MTM is the daily settlement of the profit or loss that arises from price movement.

A trader may have the funds to enter a futures position but still find themselves in a cash shortfall later on if the market moves against them.

Before you go in on a futures trade you should bear in mind the contract value, the margin required, the possible daily loss, the expiry date and the funds available to meet your settlement obligations.

Understand the settlement before trading

Futures trading is more than just working out whether the price is going to go up or down. You also have to understand how margins are calculated, how daily settlement works and what happens when you're in a losing position.

Platforms such as Ashika Dhanush 2.0 may give you access to futures trading and the relevant market data (depending on the features available and your eligibility). The margin requirements and settlement obligations will be as per the rules of the relevant exchange and clearing house.