Margin Tick Value and Leverage
Jordan Schleider founder and head trader at NQ Trader
I am here to tell you a little about futures trading. So you want to get involved in futures trading but you do not know how or where to start. Sound familiar?
Let’s say you think the e-mini’s markets are a good choice, one that could last for months. Let’s also assume you like the NQ market better than all the other e-mini markets. You think there is real potential in the NQ because of the world wide Tech demand. Not only do you like the fundamentals, but you also like the technical trend.
You look at the charts and it is in a bullish up trend. All the moving averages are trending up, and your momentum indicators are all bullish. The example I am using is for the NQ market, but you could have a bullish or bearish opinion in Crude Oil, Gold, US 10 Year Note, S&P 500, Soybeans, Cattle, Sugar, the US Dollar or any other futures market for that matter. You can use the following exercise as a guide to make your first trade in any commodity futures market.
A futures contract of the NQ is worth 20 shares and it moves in 25 cent increments. Let’s say the NQ is trading at $5,500/share and moves up 25 cents to $5,500.25 /share. The NQ went up 25 cents, but it went up 25 cents for 20 shares in the futures contract. The 25 cent gain needs to be multiplied by 20 shares.
$0.25 X 20 shares = $5.00
25 cents in the NQ equals $5
So the next time you see on CNBC, Bloomberg, the Wall Street Journal, or any other financial news organization that the NQ is up $40.25 for the day, you will know to multiply it by $5 to get the monetary move in the standard futures contract.
$40.25 / .25 = 161 ticks X $5 per tick = $805 per contract.
Total Futures Contract Value
Now that you know the dollar amount for price changes, the next thing you need to know is what these futures contracts are worth as a whole. In order to figure that out, we need to know the total value of the futures contract.
If the NQ is trading at $5,500/per share and a contract of the NQ is for 20 shares, to find the total contract value, we need to multiply the price per share by the number of shares in the contract. In this case we need to multiply price ($5,500.00/share) by the contract multiple (20 shares of the NQ)
$5,500 X 20 shares = $110,000
That means one standard contract of the NQ trading at $5,500 is a $110,000 futures contract.
Does this mean you need $110,000 in your account to trade the NQ futures contract? Absolutely not. Commodity futures are traded on margin, where you only need a percentage of the total contract value to hold a position. We will dive into this further in the next section.
Margin is the minimum amount of available funds you need in your account to hold a futures position. Each market will have a different margin requirement. Margins are determined by the exchanges. The margin for the standard 20 shares of NQ contract for overnight trading is around is $5000 and the intraday margin for day trading is $500. Margin is not the recommended amount of capital you need for a position. Margin is just the minimum amount of capital the exchange and clearing firms want traders to have in their accounts.
Leverage and margin are similar but separate subjects. Margin is the minimum amount of capital you need to hold a position. Leverage is the ability use a specific amount of capital in order to control a much larger asset in terms of valuation.
The most prominent example for the use of leverage is when a person buys a house; they are using leverage by taking out a mortgage. Let’s say you want to buy a house and the price is $200,000. The bank wants you to put down 10%, which is $20,000. The other 90%, or $180,000, is mortgaged. The note covers the first $180,000 of the house and the home owner has equity of $20,000.
As the price of the house increases, the gains made go to the home owner. If the house increases in value by 10% ($20,000) to $220,000, the mortgage is still $180,000, but the homeowner’s equity is now $40,000. The homeowner has a 100% return on his investment and the price of the house only had to go up 10%.
Leverage can be a double edged sword. Let’s say the price of the home decreases by 5%, or $10,000. That means the price of the home is only worth $190,000. The mortgage is still $180,000. However, the home owner’s equity in now $10,000, down from $20,000, which is a decrease by 50%. The price of the home only had to decrease by 5% for the home owner to have a loss of 50% in their equity.
You can take the same concept of leverage with respect to buying real estate and apply it to trading futures. Let’s say you have a $10,000 futures account. You are long soybeans at $6.00/bushel. The total contract value is $6 X 5000 bushels = $30,000.
If soybeans goes up 20 cents from $6.00 to $6.20 per bushel, the trader is up $0.20 in soybeans, or $1000 ($0.20 X 5000 bushels). The price of soybeans went up about 3% but the trader’s equity increased 10% (from $10,000 to $11,000). If soybeans goes down ten cents ($0.10) from $6.00 to $5.90 per bushel, the trader is down $0.10 in soybeans, or $500. While the price of soybeans is down almost 2%, the trader’s equity is down 5% percent (from $10,000 to $9,500).
Just like how a homeowner can choose their leverage by using a 5%, 10%, 20% or even 50% down payment on a home, so too can the futures trader. A futures trader with a $10,000 account can be long 1 futures contract, controlling $30,000 of soybeans, they can be long 2 futures contracts, controlling $60,000 of soybeans, and to use a very aggressive example, they could even be long 4 contracts of soybeans controlling $120,000 worth of soybeans (4 contracts X $2025 margin = $8100 of required margin for the sample $10,000 account).
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