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Margin & Leverage
Margin is the amount of money investors need to deposit and maintain at a certain prescribed level to hold a futures contract. For example, the initial margin for one COMEX gold contract is approximately USD10,000 for 100 troy oz of gold. This enables investors to own a large amount of asset with a smaller amount of capital (margin). For example, if the market price of gold is USD1, 600 per troy ounce, an investor will need to pay USD160,000 in cash to own 100 troy ounces of physical gold. However, by holding one COMEX gold futures contract, investors will only need to pay USD 10,000.
Margin is related to the ability to leverage, which is one of the most distinct advantages in trading futures. Leverage is the most powerful tool available in futures trading as it allows investors to control an asset of greater value compared to their initial investment. Investors are able to efficiently use their capital to boost their returns on their investment. Let us look at an example to illustrate this distinct feature:
If a cash trader buys 100 oz of gold at USD 1,600 per ounce, he would have to pay USD160,000 for the purchase. This is a cash purchase without leverage. If a savvy trader buys one COMEX Gold Futures Contract which is equivalent to 100 oz per contract, he only needs to put up approximately USD10, 000 for the purchase. The COMEX Gold contract has given the savvy trader 16X leverage.
If gold prices were to go up 10%, both the cash and savvy trader would have made USD16,000.
However, the return would have been 160% for the savvy trader whilst the cash trader would only have earned 10%.
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