Margins on futures — SPAN, exposure and MTM

Here is a puzzle that catches almost every newcomer to futures. You study a stock, you form a view, and — this is the painful part — you turn out to be right. The stock does rise, exactly as you thought. And yet you end the month with a loss, because you were no longer in the position when it happened. You were closed out days earlier, at the bottom of a dip, by your own broker.

How can you be right and still lose? The answer is not in the stock. It is in the plumbing of how a futures position is funded and settled — the margin you post to open it, and the cash that moves in and out of your account every single day until it closes. That daily settlement, called mark-to-market, is the mechanism that can eject you from a trade before your view has a chance to come good.

This module is about that plumbing. It is not exciting, and that is the point: the boring machinery of margin and daily settlement decides who survives long enough to be right. Get it wrong and you will keep meeting people — you may be one — who "called it perfectly" and still lost the money.

Recall from the previous module what a futures contract is: a promise to settle the difference between today's agreed price and the price at expiry, on a large quantity of the underlying, for only a fraction of its value posted upfront. That fraction is the margin. The full value the contract controls is the notional — the lot size times the price — and it is many times bigger than the margin you actually put down.

That gap is the whole problem the exchange has to solve. If you control ₹5,00,000 of stock with ₹1,00,000 of your own money, and the stock falls 20% overnight, your ₹1,00,000 is gone and there is a further loss with no cash standing behind it. Multiply that across thousands of traders and one bad day could break the market itself. So the exchange refuses to let losses accumulate quietly until expiry. Instead it collects them as they happen.

Two devices make this work, and you must know both by name.

First, the money taken before you trade. To open one lot you must post the initial margin — the total upfront cash blocked against the position. It has two parts. The larger part is SPAN margin, a figure the exchange's risk system recalculates through the day, sized to cover a large but plausible one-day loss on your exact position. On top sits the exposure margin, an extra buffer for the sudden move that a normal day would never show. Together they might be 15–25% of the notional for an index future, and more for a jumpy single stock.

Second, the money moved while you hold. Every day at the close, the exchange marks your position to the settlement price and settles the day's profit or loss in cash. This is mark-to-market, or MTM. If the position moved your way, cash is credited to your account that evening. If it moved against you, cash is debited — real money leaves — and if that drops your account below the margin now required, you get a margin call: add funds at once, or the broker closes the position for you.

Notice what this means. Your loss is not a paper number you can wait out. In futures it is a daily cash event. The market does not politely hold your unrealised loss until you are proven right. It comes and collects, at the close, every day. You have to survive each day to reach the day you were right about.

Walk the mechanism slowly, because the sequence is what traps people.

Day zero. You post the initial margin — SPAN plus exposure — and the exchange blocks it. You now hold one lot. Nothing has been earned or lost yet; you have simply put up the deposit.

Each evening. The exchange fixes the day's settlement price. Your position is compared to the previous settlement, and the difference on the whole notional is settled in cash. Up day: money in. Down day: money out. This repeats, mechanically, every trading day.

When the account falls short. Two things can push you below the line. The obvious one is a run of down days draining cash through MTM. The quieter one is that the required margin itself can rise — when a stock gets volatile, the exchange's SPAN system lifts the margin, so the bar goes up at the very moment your cash is going down. Cross below it and the margin call arrives.

The square-off. If you cannot or do not add cash, the broker sells your long (or buys back your short) to close the position. This is not a threat; it is an obligation the broker has to the exchange. It happens at whatever price the market is showing then — often a bad one, because forced selling clusters exactly when prices are already falling.

The cruelty is in the timing. Margin calls and square-offs bunch up at the bottom of moves, when volatility is highest and prices worst, because that is when accounts breach and SPAN margins jump together. You are most likely to be forced out at the least favourable price the move will offer.

The bars are your account, draining as MTM takes the down-day losses in cash. The dashed line is the stock — which dips, trips the margin call on day 3, and only then climbs back above where you bought. You were right about the line. You lost money on the bars.

Put real numbers on it. illustrative

You have ₹1,20,000 in your trading account. You are bullish on a stock trading at ₹1,000. Its futures lot is 500 shares, so one lot's notional is ₹5,00,000 — over four times your account and five times the margin, controlled with a slice of it. The exchange asks for ₹75,000 SPAN plus ₹25,000 exposure: ₹1,00,000 initial margin. You buy one lot long. Your spare cushion above the margin is a thin ₹20,000.

Now the days unfold. On day 1 the stock ticks down to ₹988 — a mild 1.2% dip. On the 500 shares that is a ₹6,000 loss, debited that evening by MTM. Account: ₹1,14,000. Day 2 it slips to ₹975: another ₹6,500 out. Account: ₹1,07,500 — still above the ₹1,00,000 margin, but the cushion is nearly gone. Day 3 brings a rough session and the stock touches ₹940. That is a further ₹17,500 MTM debit, taking your account to ₹90,000 — below the ₹1,00,000 required. Worse, the drop has made the stock jumpier, so SPAN nudges the required margin up. The margin call lands. You have no spare cash to add today. The broker squares you off near ₹940.

Your realised loss: the stock fell from ₹1,000 to ₹940, ₹60 on 500 shares — ₹30,000 gone, a quarter of your account, in three days.

Then the story turns. Over the next week the stock does exactly what you predicted: it recovers and climbs to ₹1,050 by day 10. Had you held one lot from ₹1,000 to ₹1,050, that is +₹25,000. You were right. But you were not there. The path drained your cash and tripped the call before the destination arrived. Your correct view earned someone a profit — just not you.

Sit with the arithmetic, because it is the spine of futures. A 6% move against you, on a ₹5,00,000 notional, is ₹30,000 — a quarter of your account, and it came out in cash, on a schedule you did not control, at a price the forced sellers set. The same 6% dip in a plain cash holding would have been an uncomfortable paper wobble you could have ignored. Leverage did not just multiply the loss; it changed its nature, from a number on a screen to money leaving your account on a deadline.

It is tempting to read the initial margin as a worst-case number — "the most I can lose is the margin." It is nothing of the sort. The margin is the exchange's estimate of a plausible one-day loss, collected so the system stays solvent. It is a deposit against normal volatility, not a cap on your losses.

Your actual loss can exceed the margin, and on the wrong day it will. Futures gap. A stock can open 15% below yesterday's close on bad news, before you can trade at all. When the notional moves further in a single gap than your entire margin, the MTM debit is larger than the money you posted — and you owe the difference. You can lose more than you put in. This is the feature of leverage the previous parts of this Reading kept returning to, now wearing the specific clothing of futures: the rare, violent day is exactly the one the smooth average never warns you about.

Three hard truths follow, and none of them are visible on a calm day:

The margin protects the exchange, not you. Every rule here — SPAN, exposure, daily MTM, forced square-off — exists to make sure the system is paid. Your survival is your own problem. The machinery will close your position to protect itself long before it worries about your view being right.

Volatility raises the bar as your cash falls. The margin required is not fixed. When a stock convulses, SPAN margins jump — sometimes sharply, mid-session — so you can breach the margin even without fresh losses, purely because the required amount rose. The rope gets shorter precisely when you are dangling from it.

The forced exit is at the worst price. Square-offs cluster at the bottom of moves, because that is when accounts breach together. You are structurally likely to be closed out near the low, converting a temporary dip into a locked-in loss. The small, steady comfort of "it's only down a bit" ends in one shove you cannot step back from.

The same handful of misreadings recur, and each has cost real accounts.

1. "The margin is my maximum loss." No. It is a one-day deposit, not a cap. Gaps can take more than the margin, and you owe the shortfall.

2. "I was right, so I should have made money." Being right at expiry is necessary but not sufficient. You must also survive every daily settlement in between. Direction is the destination; MTM is the road, and the road decides who arrives.

3. "Spare cash makes it safe." A buffer to meet calls buys survival, not safety. It can equally just fund a larger, slower bleed as MTM keeps debiting a losing position. Cash lets you stay in — which is only good if staying in is right.

4. "The margin looked far too big for how calm this stock is." It looks oversized on quiet days by design. It is sized for the violent day that quiet days hide. On that day it turns out to be barely enough, or not enough.

5. "Overnight positions are the only real risk." MTM runs on intraday leverage too, and the required margin can rise mid-session. The daily-settlement machinery does not wait for the overnight to hurt you.