Margin Calls

Every time a company executes a futures trade they are taking on margin risk. Margin itself is split into two different types - initial margin (IM) and variation margin (VM). IM is relatively straightforward. It is essentially a down payment that needs to be made in order to access that contract on the exchange (or off the exchange if you're trading OTC). The advantage of IM is that it is typically only a fraction of the nominal value of the executed trade.

For example, at the time of writing, to execute a copper futures trade on the London Metal Exchange costs an initial margin of $18,925 per lot. However, given each lot is 25mt, and the current 3-month price for copper is ~$12,650 the nominal value of the contract is $316,250. To trade a copper future you only need to come up with 6% of the value of the contract. Considering that most companies are trading a lot more than one contract at a time, you can see the value of only paying a fraction of the contract value. Let's say a larger trading company wants to buy 300 lots of copper or 7,500mt - the nominal value is ~$94,875,000 but they would only face an IM of $5,677,500. This is what is known as trading with leverage. The company is never required to pay the full value of the contract because when they close out their position, they will be square and will simply either pay or receive the resulting P&L from the trade.

This is where VM comes into play. VM works like a running mark-to-market value of any executed trades from the point of execution until such a time the trade is closed out. For example if you are long futures, VM will be calculated until you sell the equivalent amount for the same maturity date and vice versa if you are short futures. Take silver for example - let's say a company sold silver futures back in November 2025 at $50/oz with a settlement date of Jan 30th 2026. Each day their broker would calculate the difference between the executed price ($50/oz) and the daily settlement price for silver. Since this trader had sold futures, if the current market price for silver is above $50/oz, they would be in negative margin. It would cost them money if they closed out their short futures trade today at the higher price. If the current market price was lower than $50/oz, they would be in positive margin - they would be making money if they closed out their short position at market.

Given the historically rapid rise to almost daily all time highs we have seen on silver over the last couple of months, this is the exact position a lot of traders have been in. Let's say a bank shorts 1 million oz of silver at that $50/oz level. At a price of $75/oz, they would face a negative margin of $25m. And we all know there are some banks that are a lot shorter than 1 million oz of silver! Rumors were that some banks were facing margin calls in the billions on their silver positions.

Often, IM and VM is handled through credit lines offered by brokers to incentivize traders to execute their business through that broker. However, these lines are not unlimited and any time margin positions exceed any credit line extended, the difference will need to be paid in full by the trader. This is what is known as a margin call. Let's say a trader has a VM credit line of $10m. If their VM goes to negative $10.5m they will be margin called for the additional $500k. This money will need to be paid the same day it is requested by the broker. Should the trader's VM move back within the credit line, that $500k would be returned to the trader. However, if their VM continued to move further into negative territory, they would be obliged to continue to fund the excess on a daily basis.

Now, most of the time VM is perfectly manageable by companies as part of their daily trading activities. Most large speculators will operate with agreed position and risk limits so they know their max losses, using effective risk management techniques such as stop-losses that cap potential losses at manageable levels. There are some speculators of course that do not follow the same strict risk management procedures and leave themselves exposed to these large swings in VM.

However, for physical traders, VM can be somewhat of an unknown entity. Most physical traders are long physical product before they are short, meaning they will buy goods before they sell them. Sometimes they will also carry significant stocks of material to ensure they have product on hand for on-time deliveries. Those physical traders that hedge, will be inherently short futures when they price their physical purchases.

This creates a unique scenario for physical traders whereby large short futures positions can be amassed simply by following correct hedging processes. Let's say a company trades 20,000mt of copper per month, and typically has a 1-2 month delay between pricing their physical purchases and sales. This means they could have anywhere from 20-40,000mt of short copper futures on their book on a given day. We have seen copper increase $2,000/mt in the past two months on the LME. A company with a 30,000mt short futures position that priced their purchases at $10,500/mt would currently be facing a VM on that position of negative $67.5m!

Margin calls cannot typically be financed in the same way that companies finance their physical product such as borrowing bases and RCFs. Cash payments are required to pay any margin calls - I'm not talking about money in briefcases, but company liquidity. You can see just how quickly VM can become an issue for companies simply through their regular trading activities.

Failure to meet margin calls will have catastrophic consequences for a trader. Unless a solution can quickly be worked out, the broker would immediately begin to liquidate open futures positions to protect themselves against further losses. It would severely impact a traders credit rating and ability to access exchanges and also trade physical product - the commodity world is very close-knit so word of default would immediately spread.

This is why it is imperative that front-office work hand in hand with the finance department at every trader. Constant communication is required surrounding positioning - whether those positions are linked to physical trading or speculative trading. The finance department needs to ensure that regardless of price action, a company positions will not be compromised and they will always be able to meet any margin call obligations.