Consider a trade between a gold jeweler and Mr. Amit. Amit has entered into a contract with gold jeweler where he agrees to buy 10Kgs of gold at Rs. 3000/- per gram after a period of 3 months. But due to the recent COVID-19 crisis, the value of the gold rose to a very high level. This resulted in the loss of the gold jeweler and profit for Amit. Had it been the case that the jeweler disagreed to respect the contract, it would have been followed with a long and grueling legal case. To prevent such cases, a concept of margin came into existence.
What is Margin?
Margin is the collateral taken from the exchange from the trader when he enters into a leveraged derivative contract. But what does leverage mean? It is a feature that enables the trader to take a position that is much larger than his/her capital. Say, to buy 1 Bitcoin for $5,000, a trader with a capital of $500 can borrow $4500 in margin trading. In this situation, the leverage of the trader is 10x.
What are the types of Margin?
Crypto derivatives trading platform has below mentioned margins
Initial Margin: It is the minimum amount required to enter a new position as well as the minimum amount needed to keep that position from getting liquidated. The initial margin varies from the price of the contract and depends on the position size.
A trader buys 6,000 BTCUSD contracts at 10,000 USD with 25x leverage.
Initial Margin = Quantity of Contracts / (Order Price × Leverage)
= 6,000/(10,000×25)
= 0.024 BTC
Maintenance Margin: It is the amount that will assist the trader to hold his/her positions. The moment the cash balance falls below the maintenance margin, the exchange will ask you to deposit more money or else it will trigger the liquidation. That means the exchange will force themselves to close the positions on their own.
A trader buys 6,000 BTCUSD contracts at 10,000 USD with 25x leverage.
The maintenance margin used for this position is:
Maintenance Margin = (Quantity of Contracts / Order Price) × Maintenance Margin Rate
= (6,000/10,000)×0.5%
= 0.003 BTC
Initial Margin = 6,000/(10,000*25)
= 0.024 BTC
This means that this position may have an unrealized loss of up to 0.021 BTC (0.024 BTC – 0.003 BTC) before the occurrence of liquidation
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