How Futures Margin and Mark-to-Market Work: Posted, Restruck, Returned

Margin is collateral that both sides lodge before a cleared position is carried at all, and mark-to-market is the daily restrike that turns each day's price change into cash on the day it happens. The position is revalued at the day's settlement price, the change is taken out of one margin balance and put into the other, and what either side owes is therefore collected as it arises instead of piling up until the end.

Underneath that sit two problems and one answer to both. A promise made today for a payment much later grows into an amount somebody owes, and it grows exactly as the referenced thing travels away from the price the two sides agreed. Left alone, the amount gets biggest at exactly the worst moment. The side that has to find it is then least able to. So collateral is taken before anybody is allowed to carry the promise, and the change is swept up every single day so that it never has the chance to become large enough to be worth abandoning.

What actually leaves the holder's hands when the position is opened?

Begin with the biggest surprise. Nothing at all is paid to acquire either side of a futures contract, so the only cash that has left is the collateral, and the collateral is coming back. Neither side is buying the position from the other. Neither hands the other a purchase price. Both accept an obligation to settle at an agreed price on a later date, and obligations do not have a ticket price. Each side does put up a deposit against its own promise, held while the promise is open and released when it is over.

A large deposit lodged with a landlord before the keys change hands has the same shape. The deposit is not rent, and it is not the price of the flat. The deposit sits with somebody else because the arrangement needs a reason to trust the tenant, and it comes back at the end adjusted for whatever it had to absorb. Nobody records that deposit as the cost of living in the flat, and nobody should record margin as the cost of a futures position either.

On an invented reference asset, the arithmetic is small enough to hold in the head. The reference asset trades at Rs 2,000.00/- for delivery now. Money costs 6.50 per cent a year to borrow. Whoever is holding the reference asset over that year collects nothing at all for holding it. The financing rate applied to the price gives carry of Rs 130.00/- for the year. Set on top of Rs 2,000.00/-, that makes the price agreed for the later date Rs 2,130.00/-. The agreed price is a cost worked out, not a view about where anything is heading.

One unit of that reference asset carries Rs 2,000.00/- of exposure. An initial margin of 8.0 per cent of that exposure is Rs 160.00/-. The 8.0 per cent here is a teaching figure, not a requirement from anywhere. The Securities and Exchange Board of India (SEBI) writes the rules a clearing corporation then sets its real requirements under, at sebi.gov.in. Real requirements sit differently on one contract than on the next, sit differently today than yesterday, and are revised. The teaching figure carries the shape of the arithmetic and nothing more.

Where does the lodged amount actually sit? Not with the other side of the position. The deposit goes to the party that stands between the two sides, through the participant that faces that party for the holder, and it is held under rules about segregationHolding what a participant lodged apart from anything the intermediary lodged for itself, so the two pools cannot be run together. and about what may be lodged in the first place. Which assets count as eligible collateralThe kinds of assets an authority permits to stand as security, rather than whatever the person lodging it happens to have., and what haircutA cut applied to what a lodged asset is counted as being worth, so it stands behind less than the amount it would fetch. is applied to each of them, are decided by the authority. SEBI writes those rules, at sebi.gov.in.

What does Rs 160.00/- posted say about the size of what stands on it?

Two figures have to be read side by side here, and reading either one on its own misleads. The first is what was lodged. The second is what stands on top of it. Rs 2,000.00/- of exposure sitting on Rs 160.00/- of collateral is 12.50 times: every rupee lodged is standing under twelve and a half rupees of reference asset. That multiple, rather than the exposure and rather than the notional, is what makes a cleared position feel different in the hand from anything bought outright.

Now put the multiple against an ordinary day. Take a move of 4.0 per cent against the position, measured on the Rs 2,000.00/- of exposure. The move comes to Rs 80.00/- of reference asset price. Set the Rs 80.00/- against the Rs 160.00/- lodged and it swallows exactly half of it. Four per cent on the referenced thing removes one rupee of every two put down. Pushed a little further, the arithmetic gets blunter still: a move of one part in 12.50, which is 8.0 per cent of the exposure, takes the whole of it. On the invented percentage used here, a price falling from Rs 2,130.00/- to Rs 1,970.00/- leaves a long position with nothing at all of its Rs 160.00/- still standing.

A frequency and a ratio are different claims. How often a 4.0 per cent day arrives is a question about a price series, and an invented reference asset has none, nor a distribution, nor a probability of any kind. The ratio needs none of that, and it holds whatever the real collateral percentage turns out to be. Halving the percentage doubles the multiple. Doubling the percentage halves it. The multiple survives every change in the number that produced it.

What does the clearing corporation do to an open position when the day ends?

At the end of the day the party in the middle strikes a settlement price for that contract. Every position still open is then restruck at it. Restruck means the position is measured against a new starting point: the difference between the day's settlement price and the price the position was carried into the day at is worked out, and after that difference has been dealt with, the position is treated as though it had been opened at today's settlement price.

The daily restrike is why the agreed price stops being the price the position is measured against, and becomes only the price it was measured from. On day one of the worked path, a long position of one unit is carried in at Rs 2,130.00/-. The day settles at Rs 2,110.00/-. Subtract the price carried in from the price the day settled at, so Rs 2,110.00/- against Rs 2,130.00/- leaves minus Rs 20.00/-. Once that is settled, the position is carried at Rs 2,110.00/-, and tomorrow's change is worked from there rather than from Rs 2,130.00/-.

Two words for the same joinery. A single step puts the party in the middle on both sides of every trade, and after it neither original side answers to the other. The step is called novationA step that replaces one agreement with two, so each side ends up facing a different name while the terms it agreed stay as they were.. And when a participant holds several positions at once, what moves is usually the result of nettingAdding what is owed in both directions between the same two parties and moving only the difference, rather than sending two payments past each other. rather than one payment for every position separately. The plumbing of the party in the middle, how it is capitalised and who governs it, is covered separately.

The time of day this happens, and anything further that may be called for before the day has closed, are both fixed by SEBI at sebi.gov.in.

Where does the day's change actually go?

The day's change goes across, not away. The Rs 20.00/- is taken out of the long side's margin balance and put into the short side's margin balance, on the same day, in the same amount. The day's change is a transfer between the two sides and not a fee charged to either of them. Nothing has been consumed. The two entries sum to nil. The party in the middle keeps none of it. Keeping it was never the purpose. The purpose is to make sure the entry that leaves one account is the entry that arrives in the other.

The two sides of a household bill make the same shape. If one person pays the electricity and the other transfers half of it back, the household is not poorer by the transfer. Money has moved between two pockets in the same house. The transfer stops one pocket carrying the whole obligation while the other carries none. Daily settlement does precisely that job between a long position and a short position.

Two events are being described here and it pays to keep them apart. One is the restrike, an accounting act: the position is revalued and the balances are adjusted. The other is money physically moving, on its own timetable. SEBI settles how long the settlement cycleThe interval an authority allows between a deal being done and the money, or the referenced thing itself, actually changing hands. runs, for cash and for the referenced thing alike, at sebi.gov.in. The gap exists, and a balance shown on a sheet is a balance after the restrike, whether or not the cash has finished travelling.

What happens to the balance on a day that runs against the position?

The balance falls by the day's change and by nothing else. The rule is the whole of it, and it is why a balance can always be reconstructed without being told. Starting at Rs 160.00/- and taking away the Rs 20.00/- the day cost leaves Rs 140.00/-. No fee has been slipped in. No interest has been added either. Nothing is earned on a balance of collateral in this arrangement.

If the balance keeps falling, at some point the party carrying the position is asked to put more in. How far it may fall first, when the request goes out, how long there is to meet it and what follows if it is not met are each a clearing corporation's to set, under rules SEBI writes at sebi.gov.in. No two contracts need carry the same answer, and every answer is revised. A figure supplied from recollection would be read against a rule that has since moved, and being confidently wrong about a deadline costs more than knowing where to look it up.

One more term belongs here. When a member does fail, the losses are met from a set of resources in an order decided in advance. The order is called a default waterfallAn order agreed in advance saying which pot of money is drawn on first, which second and which after that when somebody fails to pay.. The order is fixed before anybody knows which side of it they will be standing on. The drafters of such an order are writing at a moment when they cannot yet tell whom it will favour, and that is the whole source of its authority. The steps themselves, and every threshold inside them, come from SEBI at sebi.gov.in.

Why is any of this done every day instead of once at the end?

Consider the same promise settled once, at the end, with nothing collected in between. The amount one side will eventually owe keeps growing for as long as the reference asset keeps travelling away from Rs 2,130.00/-. There is no ceiling on it in the arrangement itself. Worse, the amount is largest exactly at the moment the side that owes it has had the longest run of bad days. Finding it is hardest then too.

Now consider the same promise restruck every day. Yesterday's change was already collected yesterday, so the amount owed at any moment is one day's change and never more. The obligation is not allowed to accumulate into something worth walking away from. Nothing about the total has been altered by this. Only the timing has moved, and the timing is the entire point of the exercise.

Most readers have already lived a version of this at home. A shopkeeper who lets a customer run a tab for a year is carrying a growing amount owed and cannot tell, until the year is out, whether it will be paid. The same shopkeeper settling in full at the end of each week is never owed more than one week, and never has to make a judgement bigger than one week's worth. Neither arrangement changes the total the customer spends. The arrangements differ in how much is ever outstanding at once, and therefore in how much has to be trusted.

What does the whole sequence add up to on the final date?

Here is the path with every rung printed, and no balance on it arrives from nowhere. The position is carried into day one at the price agreed, Rs 2,130.00/-. The agreed price came from running Rs 2,000.00/- out a year at financing of 6.50 per cent a year. No income stream is attached to this reference asset, so nothing comes off the carry.

Put minus Rs 20.00/- beside plus Rs 40.00/- and the pair leaves plus Rs 20.00/-; run the price from Rs 2,130.00/- up to Rs 2,150.00/- in a single move and that leaves plus Rs 20.00/- too. The instalments and the single payment land on the same figure, to the rupee. The match is not a coincidence of the numbers chosen. It is forced. Each day's change is the difference between two consecutive prices, everything in between is added once and taken away once, and adding a run of consecutive differences therefore leaves only the first price and the last.

Any statement handed over can be checked against the identity underneath, and the identity is worth stating on its own.

Test it on the worked path. After day two, Rs 160.00/- plus Rs 2,150.00/- less Rs 2,130.00/- gives Rs 180.00/-. The ladder printed the same. Now change day one and leave day two alone. Suppose day one had settled at Rs 2,050.00/- instead: the change would have been minus Rs 80.00/-, the balance would have dropped to Rs 80.00/-, and day two would then have brought plus Rs 100.00/-. The balance after day two is Rs 180.00/- again. Two entirely different day ones, and the same closing balance. The closing balance depends on the last settlement price and not on the road to it.

Does any of it change when the holding is bigger?

Take the same two days on forty contracts, and treat each contract as one unit throughout. Treating each contract as one unit is a teaching simplification. How much of the reference asset a single contract is written over belongs to the exchange, and SEBI stands behind that at sebi.gov.in. One contract need not stand over the same quantity as the next, and the quantity moves. One unit apiece is used here purely so the multiplication stays readable.

Collateral first. Forty times Rs 160.00/- is Rs 6,400.00/-. Day one takes forty times Rs 20.00/-, or Rs 800.00/-, leaving Rs 5,600.00/-. Day two brings forty times Rs 40.00/-, or Rs 1,600.00/-, taking the balance to Rs 7,200.00/-. Check it against the identity: Rs 6,400.00/- lodged plus forty times the Rs 20.00/- the price has travelled since the position opened is Rs 7,200.00/- exactly.

Now the two quantity readings on that same holding, and they are different numbers with different jobs. Forty at the spot price of Rs 2,000.00/- gives Rs 80,000.00/- of exposure, the quantity the collateral figure was struck on. Forty at the agreed price of Rs 2,130.00/- gives Rs 85,200.00/- of notional instead, a face amount which stays exactly where it is: none of it travels, then or later.

Rs 80,000.00/- of exposure divided by Rs 6,400.00/- of collateral is 12.50 times, exactly the multiple one unit gave. That is worth pausing on. Both limbs of the multiple grew together, so the multiple did not grow with the holding. Leverage on this arrangement is a property of the arrangement itself and not of how much of it somebody is carrying. Buying forty times as much does not make each rupee lodged carry more; it makes there be forty times as many of them.

One more reading of the same day one puts the multiple and the change into a single sentence. Day one cost the position Rs 20.00/-. Against the Rs 2,000.00/- of exposure that is 1.00 per cent. Against the Rs 160.00/- lodged, the very same Rs 20.00/- is 12.50 per cent. The two readings differ by exactly the leverage multiple, and that difference is leverage stated as a number on a statement rather than as a word. And the reason the share of collateral reads 12.50 per cent while the multiple reads 12.50 times is that the day happened to move exactly one per cent; on any other day the two figures part company immediately.

Who reads these figures, and which box does each of them fill in?

Four different sheets carry a box that only these numbers can fill, and the four boxes want four different figures out of the same day. Framing it by the box rather than by the job is the quickest way to see why one number is never enough.

The obligations file at a clearing member has a box for the day's change on every position it carries for every participant, and the figure that goes in is minus Rs 20.00/- a unit, before any netting across the participants it acts for. The file does not want the balance and it does not want the exposure. Only the movement has to be collected or paid on, and only the movement goes in the box.

A treasury cash plan has a box for money leaving in the next few days, and the figure that goes in there is the same Rs 20.00/- a unit, but written as an outflow with a date attached to it. The amount cannot be known in advance. It is whatever the day's settlement price makes it, and a box that has to be filled with an unknown amount is the hardest of the four. A cash plan that budgets nothing for it has budgeted for the reference asset never moving.

A risk sheet has a box for how much of the referenced thing the desk is standing on, and the figure that belongs in it is Rs 2,000.00/- of exposure a unit, or Rs 80,000.00/- across forty. The collateral is the small number and the small number is comforting, so putting the Rs 160.00/- lodged into that box is the single most common way a position is under-stated on paper.

A household budget sheet has no box that any of these figures fills, and that is the honest answer rather than a gap. A household planning a wedding or a school fee is matching known amounts to known dates. A position that produces a different number every evening, sized by a multiple of 12.50 against what was lodged, does not belong in a row that has to be certain. Naming the sheet where a number does not fit is as much a part of reading it as naming the sheets where it does.

Should anybody carry one of these?

The question turns on four things, and not one of the four is a property of the contract. The first is what the position exists to do, a fact about the person holding it. The second is what is already sitting alongside it: a position that offsets something already held is a different animal from the same position standing on its own. The third is what cash can be found on the morning a call arrives, the question the whole mechanism keeps returning to. The fourth is what an authority requires of the person asking, settled at sebi.gov.in and nowhere else.

An invented reference asset has no history behind it, and nothing else stands in for a judgement about outcomes. How often a 4.0 per cent day arrives, and what usually follows one, are questions a real price series answers. An answer given without one would be an answer from an empty hand. Understanding how a mechanism moves money is not, on its own, a reason to put money through it. The movement itself remains, printed rung by rung, and a statement handed over can be checked against it rather than believed.