Futures and options trading definition
The phrase profit margin is also a common term, and that means something else again. On this page we explain what the term margin means in these different contexts, and provide details of how it's used in options trading.
Profit margin is a term that is commonly used in a financial sense in a variety of different situations. The simplest definition of the term is that it's the difference between income and costs and there are actually two types of profit margin: Gross profit margin is income or revenue minus the direct costs of making that income or revenue. For example, for a company that makes and sells a product, their gross profit margin will be the amount of revenue they receive for selling the product minus the costs of making that product.
Their net margin is income or revenue minus the direct costs and the indirect costs. Investors and traders can also use the term profit margin to describe the amount of money made on any particular investment.
For example, if an investor buys stocks and later sells those stocks at a profit, their gross margin would be the difference between what they sold at and what they bought at. Their net margin would be that difference minus the costs involved of making the trades.
Profit margin can be expressed as either a percentage or an actual amount. You may hear people refer to buying stocks on margin, and this is basically borrowing money from your broker to buy more stocks. If you have a margin account with your stock broker, then you will be able to buy more stocks worth more money than you actually have in your account. If you do buy stocks in this manner and they go down in value, then you may be subject to a margin call, which means you must add more funds into your account to reduce your borrowings.
Margin is essentially a loan from your broker and you will be liable for interest on that loan. The idea of buying stocks using this technique is that the profits you can make from buying the additional stocks should be greater than the cost of borrowing the money. You can also use margin in stock trading to short sell stocks. Margin in futures trading is different from in stock trading; it's an amount of money that you must put into your brokerage account in order to fulfill any obligations that you may incur through trading futures contracts.
This is required because, if a futures trade goes wrong for you, your broker needs money on hand to be able to cover your losses. Your position on futures contracts is updated at the end of the day, and you may be required to add additional funds to your account if your position is moving against you.
The first sum of money you put in your account to cover your position is known as the initial margin, and any subsequent funds you have to add is known as the maintenance margin. In options trading, margin is very similar to what it means in futures trading because it's also an amount of money that you must put into your account with your broker.
This money is required when you write contracts, to cover any potential liability you may incur. This is because whenever you write contracts you are essentially exposed to unlimited risk.
For example, when you write call options on an underlying stock you may be required to sell that stock to the holder of those contracts. If it was trading at a significantly higher price than the strike price of the contracts you had written, then you would stand to lose large sums of money. In order to ensure that you are able to cover that loss, you must have a certain amount of money in your trading account.
This allows brokers to limit their risk when they allow account holders to write options because when contracts are exercised and the writer of those contracts is unable to fulfill their obligations, it's the broker with whom they wrote them that is liable.
When am I required to pay initial margin to my broker? Do I have to pay mark-to-market margin? What are the profits and losses in case of a Stock Futures position? What is the market lot for Stock Futures?
Why are the market lots different for different stocks? What are the different contract months available for trading? What is spread trading on BSE? As an investor, how do I start trading in Stock Futures?
What securities can I submit to the broker as collateral? How does an investor, who has the underlying stock, use Stock Futures when he anticipates a short-term fall in stock price?