Margin and Marking to Market

Lesson 2 showed that a futures payoff can run arbitrarily negative — there's no floor at zero the way there is for an option. Lesson 3 showed that the clearing house guarantees every futures contract will be honoured. Put those two facts together and the CCP has a problem: it has promised to make good on losses that, left to accumulate for months until maturity, could grow far larger than any one trader can actually pay. The exchange's answer is to never let a loss accumulate in the first place — settle the gain or loss every single trading day, in cash, immediately. That daily settlement process is called marking to market.

Three numbers every futures account tracks

Opening a futures position means posting collateral into a margin account held with your broker. Three thresholds govern that account:

Initial margin (IM) — the collateral required to open the position, set by the exchange as a cushion roughly covering a plausible one-day price move.
Maintenance margin (MM) — a lower threshold, typically around 75\% of the initial margin, below which the account is not allowed to fall.
Variation margin — the actual cash transferred in or out each day, equal to that day's mark-to-market gain or loss: for a long position of N units, N \times (F_t - F_{t-1}), where F_t is the day's settlement (closing) futures price.

Every day the exchange looks at the new settlement price, computes each account's variation margin, and moves cash directly from every loser's account to every winner's account — a futures market is a zero-sum redistribution machine, resettled daily. If your balance ever dips below the maintenance margin, your broker issues a margin call: you must deposit cash immediately to bring the balance back up — not merely to the maintenance level, but all the way back to the initial margin.

Worked example: five days in a copper futures account

A trader goes long one CME copper futures contract (N = 25{,}000 lbs) at a futures price of F_0 = \$4.00 per lb. The exchange sets initial margin \text{IM} = \$6{,}000 and maintenance margin \text{MM} = \$4{,}500. Track the account day by day; each day's variation margin is N \times \Delta F.

Day	Settlement price	Daily gain/loss	Balance before top-up	Deposit required?	Balance after
0 (open)	$4.00	—	—	Post initial margin	$6,000
1	$3.95	25,000 × (−$0.05) = −$1,250	$4,750	No (≥ $4,500)	$4,750
2	$3.90	25,000 × (−$0.05) = −$1,250	$3,500	Yes — margin call (< $4,500)	$3,500 + $2,500 = $6,000
3	$3.98	25,000 × (+$0.08) = +$2,000	$8,000	No	$8,000
4	$3.93	25,000 × (−$0.05) = −$1,250	$6,750	No	$6,750
5	$4.05	25,000 × (+$0.12) = +$3,000	$9,750	No	$9,750

On day 2 the balance fell to \$3{,}500, below the \$4{,}500 maintenance floor — a margin call. Notice the trader must deposit \$6{,}000 - \$3{,}500 = \$2{,}500 to get back to the initial margin of \$6{,}000, not merely up to the \$4{,}500 maintenance line. As a sanity check, total the daily gains and losses: -1{,}250 - 1{,}250 + 2{,}000 - 1{,}250 + 3{,}000 = \$1{,}250, which matches N(F_5 - F_0) = 25{,}000 \times (4.05 - 4.00) = \$1{,}250 exactly — daily marking to market always sums, over the life of a position, to the same total P&L as one lump settlement at the end would have given. Nothing about the economics changes; only the timing of the cash flows does.

The balance, plotted

The same numbers, as a path: the balance drifts down through days 1 and 2, dips below the maintenance line (dashed), snaps back up to the full initial margin the instant the trader tops up, then rides the daily gains and losses of days 3 through 5.

A forward contract settles once, at maturity — which means an unrealized loss can quietly build for months before anyone has to actually produce the cash. If a counterparty's fortunes have collapsed by the time that bill finally comes due, there's nothing left to collect: exactly the counterparty risk Lesson 3's clearing house exists to remove. Daily marking to market caps the clearing house's maximum exposure to any single trader at roughly one day's price move, because losses are swept into cash the very next morning rather than left to compound. It's the same insurance idea as the CCP itself, pushed down to daily granularity: never let unrealized risk sit around long enough to become unpayable.

The single most common margin mistake: assuming a margin call only requires topping the account back up to the maintenance margin level. It doesn't. Once your balance dips below maintenance margin, the required deposit brings you all the way back up to the initial margin — a bigger number, and (as the worked example shows) not simply "however much is missing from maintenance." A second common confusion: treating margin as a cost, like an option premium. It isn't — margin is refundable collateral, returned in full (plus any accumulated gains) when the position is closed. The only real cost of a futures position is the price move itself, exactly as Lesson 2's payoff formula says; margin just decides when that P&L is realized in cash, not whether it exists.