In finance, a margin is collateral that the holder of a position in securities, option, or futures contracts has to deposit to cover the credit risk of his counterparty. This risk can arise if the holder has done any of the following:
- borrowed cash from the conterparty to buy securities or options,
- sold securities or options short, or
- entered into a futures contract.
The collateral can be in the form of cash or securities, and it is deposited in a margin account. The minimum margin requirement is now the sum of these different types of margin requirements. The margin (collateral) deposited in the margin account has to be at least equal to this minimum. If the investor has many positions with the exchange, these margin requirements can simply be netted.
Example. An investor sells a call option, where the buyer has the right to buy 100 shares in Apple at $120. He receives an option premium of $1.05. The value of the option is $1.05, so this is the premium margin. The exchange has calculated, using historical prices, that the option value won't go above $1.30 the next day, with 99% certainty. Therefore, the additional margin requirement is set at $.25, and the investor has to post at least $1.05 + $.25 = $1.30 in his margin account as collateral.
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