Margin Mechanism in exchange traded derivatives

One of the primary concepts that you need to understand when you use exchange-traded derivatives, is the Margin Mechanism. Since leverage is also used by maximum people who use exchange-traded derivatives, they need to follow the process of Margin Mechanism. This seemingly complex process is actually a boon and lets even the high-risk derivatives market function smoothly. 

WHAT IS MARGIN TRADING?

Margin Trading is essentially a risk management process. It is a process by which individual investors are able to buy more stocks than they can actually afford. In India, Margin Trading also refers to intraday trading. A margin procedure is a high-ranking risk management tool and is required since a lot of contracts related to exchange-traded derivatives are highly leveraged. With the help of Margin Trading, investors can not only borrow money from the market when they need to but also invest this money back into the market. 

Margin Trading is an essential risk management tool and it safeguards the principal as well as the interest of the money borrowed in the highly speculative derivatives market. Securities are bought and sold in a single session under Margin Trading. The investor needs to speculate the stock movement for the given session. Margin Trading is used by investors to make quick money. Even small traders can access Margin Trading because of the electronic stock exchange. 

PROCESS OF MARGIN TRADING

Margin Trading appears to be a complex process but is actually very simple. When an investor opens a Margin account, he gets the facility to buy more stocks than he can actually afford at a given time. To facilitate this, the broker lends the investor money to purchase shares and have them as collateral. 

To invest in the market, you can open a trading account online. To know how to open a demat and trading account, you can log on to the website of leading broking houses. The investor needs to register a request with his broker to open a margin account. The borrowing investor pays a particular amount of money to the broker. This money is paid in cash and is called the Initial Margin. Not all brokers are allowed to lend money to investors. Only certain authorized and approved brokers can do so, and these brokers are required to maintain margin accounts in the stock exchange. 

Initial Margin: Initial Margin can be understood as the downpayment on a loan taken by you. Initial Margin safeguards the interest of the broker and even if the investor loses money in the market and is not able to recuperate the money, the broker can use this money to recover some of his invested amounts by squaring off.

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Variation Margin: Once the initial process is complete and the investor has borrowed money from the broker and invested it in the market, his investments are exposed to market fluctuations. Variation Margin can be simply understood as the settlement of profit and loss from the exchange’s account to the broker’s account and further from the broker’s account to the investor’s account. This process is done on a daily or on intraday basis. 

Margin Call: When there is a drop in the price of a call, the margin call is sent to the broker and the investor. The investor is required to pay the margin call to continue with the trade. He needs to immediately infuse cash to make sure that the initial margin is maintained. If he fails to do so, the broker will sell out the contract and recover his losses from the amount. 

Margin Trading is a tiered system and if any of the steps in the Margin Trading process is missed, their broker will square off the position to recover losses from it.