- Additional Margin System:
- The Additional Margin System is a risk management mechanism used by exchanges to protect both traders and the exchange itself from potential losses in volatile markets.
- In futures and options trading, traders are required to deposit an initial margin when opening a position. The initial margin is a fraction of the total value of the contract and serves as collateral for the position.
- The Additional Margin is an extra margin imposed by the exchange to cover potential additional losses in case of adverse market movements. This is especially relevant in situations of increased market volatility.
- The exchange may adjust the Additional Margin requirements based on factors such as price volatility, trading volume, and other market conditions. It acts as a proactive measure to ensure that traders have sufficient funds to cover potential losses.
- Margin Call:
- A Margin Call is a notification from a broker or exchange to a trader, informing them that their account equity has fallen below the required maintenance margin level.
- Maintenance margin is the minimum amount of equity that must be maintained in the trading account to keep a position open. If the equity falls below this level due to market movements, the broker issues a margin call.
- The margin call serves as a warning to the trader that they need to deposit additional funds into their account to bring the equity back up to the required level.
- If the trader fails to meet the margin call by depositing more funds, the broker may have the right to automatically close out some or all of the trader's positions to limit further losses.
Example Scenario:
- Let's say you have a futures position with an initial margin requirement of $5,000, and the maintenance margin is $3,000.
- If the value of your account drops to a level where the equity is approaching $3,000, the broker may issue a margin call, requiring you to deposit additional funds.
- If you do not meet the margin call, the broker may start automatically liquidating part or all of your position to cover the potential losses.
