Question

A trader takes the long position and a hedge fund takes a short position on ten 1-month S&P 500 futures contracts at 2500. A single S&P 500 futures contract equals ($250) × (Index Value). The initial margin is $325,000 and the maintenance margin is $245,000 for both accounts. Five trading days later, the futures price of the index drops to 2,460 triggering a margin call for the trader. What is the change margin account balance (indicate gain or loss) for: a) the trader and b) the hedge fund? How much is the margin call for the trader?

Answer 1

Initial margin is the margin required to be deposited with the exchange in order to trade (long or short) a futures contract. Here in the problem, initial margin given is the total initial margin for 10 S&P 500 futures contract which is $325,000.

Maintenance margin is the amount that needs to be maintained in the account in order to not trigger a margin call or liquidation of position. This is part of the risk management rules followed by the exchanges and the regulator. The total Maintenance margin here in this problem is $245,000.

Margin call is the event when your account value falls below maintenance margin amount specified in the contract which happens when the trade does not go your way and you incur a loss during the specified period.

In this problem, Trader is long and the hedge fund is short on 10 S&P 500 futures contract when the S&P 500 futures was trading at 2500.

After 5 trading days, the futures price drops to 2460 from 2500 earlier which has resulted in margin call for the trader who was long in S&P 500 futures.

It implies from the above info, the trader is in loss to the tune of $100,000 in his account.

Gain/Loss per contract for long position in S&P 500 futures is calculated as (current price - buying price) =  (2460 -2500)*250 = (- 40 * 250) per contract.

Total Gain/loss for 10 long positions for trader = - 40 * 250 *10 = -$100,000.

Hence, the net balance in his account is now = Initial margin deposited by trader - Loss in his positions = 325,000 - 100,000 = $225,000.

Similarly, Gain/Loss per contract for short position in S&P 500 futures is calculated as (selling price - current price) =  (2500-2460)*250 = (40 * 250) per contract.

Total Gain/loss for 10 short positions for trader = 40 * 250 *10 = $100,000.

So, the hedge fund who is short in S&P 500 futures will be in gain of $100,000.

This also explains why the trader got margin call in the first place, his account value fell below the required Maintenance margin of $245,000. The short fall here is equal to the additional amount which is required to be deposited in the account to bring the value back to initial margin. Here, $100,000 needs to be deposited in the account in order to bring the account value from $225,000 back to $325,000 (initial margin).

Amount of margin call to trader = $325,000 - $225,000 = $100,000.

Happy learning!