What Is a Gold Future Margin?
The purchase today of a futures contract on gold gives the buyer the option to either buy or settle the contract in cash or gold at the contract termination date. Gold futures contracts trade in the current month and one month in each subsequent quarter. For example, in May there will be an active contract in May and June, September, December and March of the following year. Thus, either four or five contracts are trading at all times. Margin is a down payment (or partial payment) that is due the day the contract is purchased.
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The Implications of Margin
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The buyer of the gold contract is immediately responsible for price fluctuations in the contract. It is important to understand that since the full price of the contract was not paid at the time of the trade, the margin should be considered a down payment with the remaining principal still owed. The result is that the pricing of the contract carries a premium or a trade value above the cost of the physical commodity. For example, if physical gold is trading for $1000 the futures contract due in one year may trade at $1030 (or a $30 premium). This implies a $30/$1000 rate of interest (or 3 percent premium cost) to the futures buyer.
Contract Specifications for Gold
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Contract specifications refer to the rules and regulations under which gold may trade. Gold trading rules are set by the various exchanges that trade the commodity subject to regulatory authority. In the United States regulatory authority falls to the Securities and Exchange Commission and the Commodity Futures Trading Commission. Contract specifications include the hours and days of trading, the margin requirements, the number of outstanding contract months for trading, and the requirements to be an authorized trader or broker on the exchange as well as minimum net worth requirements for individual traders.
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Margin Requirements for Gold
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Margin requirements for gold are of two types: initial margin and maintenance margin. Initial margin represents the amount that the trader must have in her account per contract at the time of purchase. Each exchange limits the total number of contracts any one individual can own. Maintenance margin is how much more money the trader must have if the initial margin is reduced from trading losses. If a trader is making money, her account rises in value and extra margin is available for trading. If a trader is losing money on a position, the trader will have to come up with additional funds to meet the maintenance requirement. A margin call is the term for traders who need to deposit additional funds to prevent the position from being sold out from the trader's account.
The Limit Up or Down Effect on Gold
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Margin requirements are the same whether the trader is long or short on the gold contract. Long refers to a buy position that the trader thinks will rise in value; a short position makes money from a decline in the value of the security. Exchanges have limits as to how much a contract may move in price in any given day. This is called the limit and should exogenous factors result in prices rising above the limit trading is halted at the limit price each day. Important news can trigger several days of limit action. If a trader has a position in gold that is contrary to the limit price, the trader is still responsible for the margin calls. The trader still cannot trade the security until gold can resume trading and is thus in a dangerous and expensive situation. Because of the riskiness of margin, some traders prefer to trade gold options rather than gold futures.
Performance of Gold as a Commodity and as a Futures Contract
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The trader has many choices when buying gold. Gold can be purchased in bars as a physical commodity for the current price of gold. Gold also can be purchased as a futures option for the margin requirement. However, most investors look at return on investment when making purchases. Thus if the price of gold rises 10 percent, the physical gold investor makes 10 percent. The futures trader makes (assuming the margin requirement is only 5 percent) makes 20 times the 10 percent (or a 200 percent return) on monies invested. Both traders have the same amount of risk, but the futures trader has only used 5 percent of the amount of monies the physical gold trader must use. Losses, however, move in the equal but opposite direction; thus, the reason for initial and maintenance positions.
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