In part 2 of our coverage of the Chinese futures market, we explore one key reason to consider trading China futures products over US futures products - margin.
What is margin in futures trading?
Before we proceed further, it is crucial for us to understand the concept of margin.
In futures trading, margin is the amount of money that you must have in your broker when you open a futures position.
Generally, futures margin represents a smaller percentage of the notional value of the contract.
How the US calculates margin for futures market:
In the US, margin calculation for the futures market is done using the CME SPAN (Standard Portfolio Analysis of Risk) methodology – which is a sophisticated methodology that calculates margin requirements by analysing the "what-ifs" of virtually any market scenario.
Parameters for SPAN methodology:
To calculate the margin requirement for a futures product, the SPAN methodology – which is a scenario-based methodology - uses the following parameters:
Price scan ranges (Scan risk) – the maximum price movement reasonably likely to occur for each instrument or, for options, their underlying instrument
Volatility scan ranges – the maximum change reasonably likely to occur for the volatility of each option's underlying price
Intra-commodity spreading parameters – rates and rules for evaluating risk among portfolios of closely related products, for example, products with particular patterns of calendar spreads
Inter-commodity spreading parameters – rates and rules for evaluating risk offsets between related products
Delivery (spot) risk parameters – rates and rules for evaluating the increased risk of positions in physically-deliverable products as they approach or enter their delivery period
Short option minimum parameters – rates and rules evaluating the irreducible minimum risk associated with portfolios of deep out-of-the-money short option positions.
In other words, under the SPAN methodology, the margin requirement of a futures product will rise when the method deduces a high likelihood of an event to trigger a larger than average activity/movement in the market, such as a FED announcement and important data releases:
Downside of SPAN methodology
The downside of this approach/methodology of determining margin requirement is a trader trading US futures products could experience fluctuating margins, especially during a volatile market, which would catch some traders off guard if they are not diligent with margin management.
How China exchanges calculate margin for futures market
On the other hand, Chinese exchanges use a methodology based on a margin rate set as a percentage of the price.
There are also other factors that can affect the margin requirement:
Different rates can be applied for long and short positions.
For some products, multipliers are used for speculator accounts.
Arbitrage (spread) margin can apply for some offsetting expiries – although a minimum margin level applies so these are limited.
Generally, the margin rates for China futures products are fixed by regulation.
As an example, the minimum trading margin for the suite of soybean futures in Dalian Commodity Exchange (DCE) are set at 5% of the notional value of the respective contracts.
As such, traders are able to calculate the margin requirement accordingly as the underlying contract value increases or drops, rather than being caught off guard by the complex SPAN methodology employed by US exchanges.
For instance, during a drop in commodity price, the US’ SPAN system may identify the drop as a volatile and risky event, hence increasing the margin requirement.
However, since China exchanges employ margin calculation based on the percentage of the notional value of the contract, a drop in a particular commodity price will generally lead to a drop in margin requirement.
Verdict: Different margin calculation approaches make for different upside and downside of respective futures markets
In this post, we looked at the different margin calculation methodologies used by both US and China futures exchanges.
I hope it is helpful and if you are keen to explore the futures market in China, check out Part 1 of my article HERE!
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Disclaimers
Any of the information above is produced with my own best effort and research.
This post is produced purely for sharing purposes and should not be taken as a buy/sell recommendation. Past return is not indicative of future performance. Please seek advice from a licensed financial planner before making any financial decisions.
Leverage is a financial tool that comes with its advantages and risks. Please learn and understand both the upsides and downsides of leverage before using it for trading.
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