Analysis of Asset Allocation

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You can use leverage techniques to increase the return of your portfolio: definitions and dangers.

FUTURES : The Margins Principle
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When two investors get in touch with each other directly and agree to trade an asset in the future for a certain price, they are obvious risks.

  • One investor would like to terminate the contract in advance.

  • One investor may not have the financial  resources to honor the agreement.

Of course, if the futures contract is traded on an exchange, the two investors are not directly in touch with each other and it is the responsibility of the exchange to cover the investors from the above mentioned risks. That is where the margins come in. The principle is exactly the same as the one used to cover short options.

When an investor enters into a futures contract, he has to deposit funds in a margin account with the broker. The amount that must be deposited at the time the contract is entered into is known as the initial margin. Depending of your broker, the initial margin can be given is the form of cash and/or securities 5see principle in the leverage section). Depending also of your broker the margin account is or is not remunerated.

But during the life of the futures contract the price of the underlying asset may fluctuate and your broker will compute the margin requirements based on the current market price. If you suffer a loss, your broker will ask you additional deposits. This mechanism is known as margin call. If you have a gain, your broker may authorize you to withdraw some funds out of the margin account (it all depends of the arrangement you have with your broker). Usually, if you don't honor the margin call, the broker is allowed to close your position.

You can see from the above that the margins principle has been implemented to cover the risks of default and, consequently, to ensure the liquidity of the market.

In the next section, we will analyze the differences between futures and forward contracts.

 


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