Futures

Your Next Margin Call Might Cost You

dondawson
Don Dawson
Instructor

There seems to be some changes for Futures traders coming soon. The Commodity Futures Trading Commission (CFTC), the government agency that regulates the Futures industry, has written some new rules that will impact Futures Commission Merchants (FCM), where customer funds are deposited. These rules will in turn impact Futures traders and their trading accounts.

Free WorkshopThe CFTC has been creating and enforcing rules in the Futures industry for a very long time. Over time, some of these rules need to be updated due to events that happen in our industry. A few of those events were the MF Global and PFGBest scandals. Just these two events alone caused more turmoil than about any other event over the last century of Futures trading. Both of these involved customer funds being abused, creating stricter regulations to go into place.

One of the new rules that will be put in place soon, if not already, will be related to something called residual interest rule. Residual interest rule is when an FCM must keep excess funds beyond customer segregated account funds that are on deposit. As an example, if an FCM had approximately $200 million of customer funds on deposit, they are required to keep approximately $210 million in segregated account funds, basically giving the FCM a $10 million buffer for customer losses.

The reason for this buffer is due to the fact that Futures trading is done using leverage, so that customers can actually lose more money than they have deposited in their trading accounts. If there was a large volatile trading day and a substantial number of the FCM’s clients lost more money than they had in their trading accounts, then the FCM would be required to step up and cover their losses until the funds are recouped from the customers. This must be done because all Futures contracts are marked to the market each trading day and funds must be distributed to the winner’s accounts immediately.

The new rule implies that if an FCM’s customer receives a margin call, then the FCM must post the margin on the next trading day regardless if the client has posted the new margin.
In the past, Futures clients were given 1-3 trading days to answer a margin call depending on the individual brokerage firm. This grace period generally did not come with any monetary expense to the client. Today, with the new rule, many of these same brokerage firms will be charging margin call fees to help preserve their own capital at risk from customers with underfunded accounts.

Some FCM’s will be charging customers $50 per day for every margin call that goes beyond a single day. So, if a customer is given a margin call at the close of Wednesday’s trading, they will have until the close of Thursday to either add funds to bring their accounts back up to the initial margin amount or risk having a fee ($50 per day) imposed on them for multiple margin calls. Other FCM’s might disregard charging any fees and simply liquidate the trader’s losing position for them. This might be the best for both parties involved. By the time a trader gets a margin call from their broker this trade has gotten out of control and the losses are mounting exponentially. A trader would be better off never to send more money to a losing Futures trade.

As a Futures trader, you may wish to contact your brokerage firm and ask how they will handle a margin call if you are ever given one.

Unfortunately, these rules are needed due to the increased risk of traders floating their margin calls “hoping” their positions turn profitable for them. If too many clients are doing this and we experience an event like the Forex market did recently having an adverse price movement, it could easily leave even the larger FCM’s insolvent.

I would like to thank Carley Garner of Stocks & Commodities magazine for reviewing the CFTC’s 600 page report and bringing this information to our attention.

“I can is 100 times more important than IQ.”

– Don Dawson

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.