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.
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.
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.
Reserved Margin: It is the difference between the initial margin which is required for the combined position (new + existing order) and the Position margin and order margin of the current derivative contract.
But what is position margin and order margin?
The margin amount reserved for all the existing positions in the derivative contract under consideration is the position margin. Whereas the margin amount allocated to all the open orders in the derivative contract under consideration is order margin. Both these margins are consumed from the wallet balance. So at any particular time, the amount that remains unused is available for placing a new order.
Available balance = Wallet Balance – (Position Margin + Order Margin)
Cryptocurrency derivatives trading system provides below mentioned margin management methods.
Cross Margin: As the name suggests, the cross margin is shared across all the open positions of the trader. That is to say, all the funds available in the wallet of the trader will be included not taking into consideration how much margin the trader has invested in. Any realized profit and loss from other positions can also help in adding a margin on a losing position. It must be noted that the liquidation can be avoided by using a cross margin since the trader will have more funds in their account balance. By default, all positions are set to “Cross Margin”.
Isolated Margin: Isolated margin is restricted to a particular amount. When the amount allocated in the isolated margin goes below the maintenance margin, the position will be liquidated. But the other funds will not be affected. In order words. all the trader will lose is his/her initial margin. This makes isolated margins good for short term speculative positions. Though an isolated margin provides this kind of flexibility, it faces a higher risk of liquidation when the market is volatile and the trader has taken a highly leveraged position. In such a scenario, the available balance can not be used to add a margin to your position.
