FINC6010 Chap.2 Futures Markets, Margins and Settlement
Futures Markets, Margins and Settlement
Futures markets manage performance through standard contracts, central clearing, margin accounts and daily settlement. This chapter follows equal and opposite variation-margin transfers from long to short positions, distinguishes initial from maintenance margin, and explains why futures converge to spot near delivery. It also keeps order instructions separate from settlement and shows how clearing changes counterparty links.
Contract specifications define the deliverable asset, grade, location, month and size so traders know exactly what the quoted price refers to. Initial margin supports performance but is not a down payment. Maintenance margin creates a trigger for replenishment after losses. Marking to market moves gains and losses every day, so a trader can face a cash demand before an underlying commercial transaction produces funds.
The clearing house becomes counterparty to both sides through novation and manages default resources, yet market and liquidity risks remain. Near delivery, spot and futures prices must meet closely enough to prevent an executable buy-cheap, sell-dear package.
The chapter also separates execution instructions from valuation: a stop-limit order controls when an order activates and the worst acceptable price, while margin accounting records what happens after a position exists.
What this chapter covers
- 01
Futures contract specifications
- 02
Initial and maintenance margin
- 03
Daily marking to market
- 04
Margin calls and restoration
- 05
Central counterparty clearing
- 06
Convergence and order types
Worked example · free
Rebuild daily margin
- 1Multiply each daily price change by contracts and contract size.
- 1Use a positive sign for a long when price rises and a negative sign when it falls.
- 1Compare each closing balance with maintenance margin.
- 2Reconcile cumulative transfers with the total price change since entry.
Key terms
- Variation margin
- The daily cash transfer created by marking a futures position to settlement price.
- Novation
- The process through which a clearing house becomes counterparty to both sides of a trade.
- Settlement price
- The exchange-determined reference used to calculate daily gains and losses on open futures positions rather than a guaranteed transaction price for every trader.
- Margin call
- A requirement to add collateral after losses push the account beneath the applicable maintenance threshold under the contract rules.
- Open interest
- The number of outstanding futures positions that remain open, distinct from trading volume, which counts transactions during a period.
- Daily settlement
- The process of crediting and debiting futures margin accounts from one settlement price to the next. It turns an accumulating terminal gain or loss into a sequence of cash transfers, reducing unpaid exposure while making interim liquidity management essential. Every transfer has an equal opposite entry.
Futures Markets, Margins and Settlement FAQ
Why are futures settled daily?
Daily settlement collects gains and losses as market prices change, reducing the unpaid obligation that would otherwise accumulate until maturity. It lowers counterparty exposure but can create liquidity pressure because an adverse position must fund margin before the physical transaction produces cash.
Is initial margin a down payment?
No. Initial margin is collateral supporting contractual performance, not part-payment for the underlying asset. The margin account changes with daily gains and losses. A separate maintenance threshold can trigger a deposit when the balance falls too far.
Why do futures and spot converge?
At delivery, a persistent price gap can support trades that buy through the cheaper route and sell through the dearer one, subject to contract and transaction constraints. That no-arbitrage pressure brings futures and spot together as the delivery point approaches.
Can two price paths create the same final futures gain?
Yes. Cumulative variation margin reconciles with the total entry-to-current price movement for a fixed position, so different daily paths can reach the same total. Their liquidity effects can differ because one path may breach maintenance margin earlier and require additional cash before a later recovery.
Exam move
Practise margin questions with a dated ledger. Record the previous settlement price, the new settlement price, the price change, the position sign, the variation transfer and the closing balance. Reconcile at the end and separately test whether maintenance margin was breached. Build one version for a long and mirror it for a short to confirm equal and opposite transfers.
Write the maintenance threshold and the restoration target on different lines before deciding the amount of a call. For convergence, explain the trade that would become attractive if futures stayed above spot at delivery and then reverse the reasoning for futures below spot. Review order types separately: translate each instruction into trigger, execution condition and uncertainty.
A limit protects price but can sacrifice execution; a market order prioritises execution but not price. Complete the set by explaining why daily settlement reduces accumulated credit exposure while increasing the importance of liquidity planning. The best revision answers connect the arithmetic to the institution that collects and redistributes the cash.
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