Q&A

Futures For You

with Carley Garner

Inside The Futures World
Want to find out how the futures markets really work? DeCarley Trading senior analyst and broker Carley Garner responds to your questions about today’s futures markets. To submit a question, post your question at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.

MARGIN CALLS
What do I do if I get a margin call?

Ideally, margin call avoidance is the best policy. However, even the most responsible traders will encounter the predicament sooner or later. Rather than liquidating positions or adding funds to what might become a money pit, there are unlimited ways to influence the exchange-required margin in your favor via risk reduction, or at least the perception of such. Naturally, lower risk equals lower margin and in most cases lower profit potential, but for those who find themselves in a dire margin situation, beggars can’t be choosers.

To understand margin adjustment, you must be familiar with the mechanics of margining in a futures and option account. Futures margin is straightforward in that there are initial and maintenance margin requirements, and although requirements are adjusted from time to time, they are relatively static.

Those trading option spreads, or a combination of futures and options, are levied margins based on a software system known as standardized portfolio analysis of risk (Span). Span in commodities is similar to portfolio margining in equities. However, equity traders must typically have $100,000 or more on deposit to enjoy the benefits of such a margining system, but futures traders of all types and sizes are automatically granted the privilege. For these traders, margin requirements are dynamic and are changing constantly.

The parameters used by Span is a closely held secret by its developer, the Chicago Mercantile Exchange (Cme). However, understanding the basics will help you determine how certain adjustments will affect your margin requirement. One of the most critical aspects of portfolio margining is figuring the account’s net position; this can be done using a simple delta calculation.

Knowing your net position: A trader should always be aware of his or her net position in each market, yet many short option or spread traders fail to realize the magnitude of their positions until it is too late.

Being conscious of the net position means knowing the aggregate long or short exposure in a particular market. For someone trading futures contracts, it is as simple as adding the longs or shorts; a trader who has purchased 10 July corn futures throughout the day is net long 10 contracts regardless of fill prices. On the other hand, a trader holding a combination of futures and options, or a combination of long and short options, must take a few extra steps to arrive at a net position.

Most brokerage firms provide a net position figure on client statements, but if you want to compute it intraday, you are left to your math skills or finding appropriate software. Because technology isn’t always available, I’ll show you how to do it using delta.

Delta: Delta is a mathematical representation of the pace of risk exposure in terms of a ratio. By definition, it is the degree of change in an instrument value relative to a price change in the underlying futures contract. For instance, an option with a delta of 0.25 will appreciate or depreciate a quarter of a point for every point that the futures market moves.

Knowing this, it is easy to see that a futures contract has a delta of 1 because for every point of price movement the market makes, the trader is gaining or losing a point. Armed with this knowledge, figuring position delta is as simple as adding the sum of each instrument delta, and this is the key to your way out of a margin call.

Adjusting delta to adjust margin and risk: Because the delta of a futures contract is 1, a trader holding a single long July corn futures is net long one July corn. That trader could lower his risk and margin by reducing the overall delta of his position. There are several ways to adjust position delta, but all would involve taking a position with the opposite directional bias.

For instance, the purchase of a put acts as an antagonist to a long futures contract because it stands to profit in a declining market, while the futures contract will profit when prices increase. In addition, the put acts as insurance against losses in the futures and lowers the overall delta. Traders long a futures contract and long a put option with a delta of 0.25 would face a position delta of 0.75 (1 - 0.25).

Similarly, selling a call option lowers the exposure of a long futures contract because a short call option benefits from lower pricing, whereas the long futures position must have higher prices to thrive. In this scenario, the trader doesn’t have the benefit of absolute insurance, but there is some comfort in knowing that the short call acts as a hedge to the existing speculative position. A trader who is long an emini S&P futures and short a call option with a delta of 0.4 is maintaining a position delta of 0.6. In other words, the position is equivalent to being long 0.6 futures contracts.

Next issue, I will discuss specific examples of purchasing or selling options around a primary speculative position as a means of manipulating the margin and risk of a particular trade.

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