Question

explain the importance of margins in derivative contracts

Answer 1

Importance of margin in derivatives:

A margin in derivatives is defined as the amount of cash an investor put ups in account to start trading. This is an initial margin requirement and is not a loan. It acts as a down payment on underlying asset and ensures that both the parties fulfill their obligations.

The importance of margin in derivatives is that it is a good faith deposit or an amount of capital that one needs to deposit to control futures contract. Margin allows the exchange to become the buyer for every seller and seller for every buyer of futures contract.

It has two benefits for market participants it guarantees anonymity and eliminates counter party risk. Exchanges which are regulated by CFTS have ample amount of funds to meet all the obligations and these funds come from margin collected by market participants.

As margin is only a small percentage of total value, there is tremendous amount of leverage in futures markets. It helps the participants to trade with confidence at all times because it holds the futures market together by acting as glue.