Margin Requirements and “Marking to Market” Protect a Futures Exchange by Making Trader Default Much Less Likely

To make sure that the clearinghouse is financially sound and does not run into financial difficulties that might jeopardize its contracts, buyers or sellers of futures contracts must put an initial deposit, called a margin requirement, of perhaps $2000 per Canada bond contract into a margin account kept at their brokerage firm. Futures contracts are then marked to market every day. At the end of every trading day, the change in the value of the futures contract is added to or subtracted from the margin account. Suppose that after buying the Canada bond contract at a price of 115 on Wednesday morning, its closing price at the end of the day, the settlement price, falls to 114. You now have a loss of 1 point, or $1000, on the contract, and the seller who sold you the contract has a gain of 1 point, or $1000. The $1000 gain is added to the seller’s margin account, making a total of $3000 in that account, and the $1000 loss is subtracted from your account, so you now only have $1000 in your account. If the amount in this margin account falls below the maintenance margin requirement (which can be the same as the initial requirement, but is usually a little less), the trader is required to add money to the account. For example, if the maintenance margin requirement is also $2000, you would have to add $1000 to your account to bring it up to $2000. Margin requirements and marking to market make it far less likely that a trader will default on a contract, thus protecting the futures exchange from losses.

—Frederic S. Mishkin and Apostolos Serletis, The Economics of Money, Banking, and Financial Markets, 6th Canadian ed. (Toronto: Pearson Canada, 2016), 320.