Editing Futures exchange (section)

==Clearing and margin mechanisms==
Futures exchanges provide access to clearing houses that stand in the middle of every trade. Suppose trader A purchases {{US$|145000}} of gold futures contracts from trader B. The reality is that Trader A has bought a futures contract to buy {{US$|145000}} of gold from the clearing house at a future time, and trader B has a contract to sell {{US$|145000}} to the clearing house at that same time. Since the clearing house has taken on the obligation of both sides of that trade, trader A does not have to worry about trader B becoming unable or unwilling to settle the contract – they do not have to worry about trader B's [[credit risk]]. Trader A only has to worry about the ability of the clearing house to fulfill their contracts.<ref>{{cite book|title=Options, Futures, and Other Derivatives|pages=2–3|publisher=Pearson|last=Hull|first=John C.|edition=9|year=2015}}</ref>

Even though clearing houses are exposed to every trade on the exchange, they have more tools to manage credit risk. Clearing houses can issue ''margin calls'' to require traders to deposit Initial Margin moneys when they open a position, and to deposit Variation Margin (or Mark-to-Market Margin) moneys when existing positions experience daily losses. A [[margin (finance)|margin]] in general is [[collateral (finance)|collateral]] that the holder of a [[financial instrument]] has to deposit to cover some or all of the [[credit risk]] of their [[counterparty]], in this case the central counterparty [[clearing house (finance)|clearing houses]]. Traders on both sides of a trade have to deposit Initial Margin, and this amount is kept by the clearing house and not remitted to other traders. Clearing houses calculate day-to-day profit and loss amounts by '[[mark-to-market|marking-to-market]]' all positions by setting their new cost to the previous day's settlement value, and computing the difference between their current day settlement value and new cost. When traders accumulate losses on their position such that the balance of their existing posted margin and their new debits from losses is below a threshold called a ''maintenance margin'' (usually a fraction of the initial margin) at the end of a day, they have to send Variation Margin to the exchange, which passes that money to traders making profits on the opposite side of that position. When traders accumulate profits on their positions such that their margin balance is above the maintenance margin, they are entitled to withdraw the excess balance.<ref>{{cite book|title=Options, Futures, and Other Derivatives|pages=30–31|publisher=Pearson|last=Hull|first=John C.|edition=9|year=2015}}</ref>

The margin system ensures that on any given day, if all parties in a trade closed their positions after variation margin payments after settlement, nobody would need to make any further payments, as the losing side of the position would have already sent the whole amount they owe to the profiting side of the position. The clearing house does not retain any variation margin.<ref>{{cite book|title=Options, Futures, and Other Derivatives|pages=29–30|publisher=Pearson|last=Hull|first=John C.|edition=9|year=2015}}</ref> When traders cannot pay the variation margin they owe or are otherwise in default, the clearing house closes their positions and tries to cover their remaining obligations to other traders using their posted initial margin and any reserves available to the clearing house.<ref>{{cite web|url=http://chicagofed.org/webpages/publications/understanding_derivatives/index.cfm|title=Understanding Derivatives: Markets and Infrastructure|work=chicagofed.org|access-date=2014-07-25|archive-date=2013-08-12|archive-url=https://web.archive.org/web/20130812135118/http://www.chicagofed.org/webpages/publications/understanding_derivatives/index.cfm|url-status=live}}</ref><ref name=HullP32>{{cite book|title=Options, Futures, and Other Derivatives|page=32|publisher=Pearson|last=Hull|first=John C.|edition=9|year=2015}}</ref> Several popular methods are used to compute initial margins. They include the CME-owned [[CME SPAN|SPAN]] (a grid simulation method used by the CME and about 70 other exchanges), [[System for Theoretical Analysis and Numerical Simulations|STANS]] (a [[Monte Carlo simulation]] based methodology used by the [[Options Clearing Corporation|Options Clearing Corporation (OCC)]]), and [[Theoretical Intermarket Margin System|TIMS]] (earlier used by the OCC, and still being used by a few other exchanges).

Traders do not interact directly with the exchange – they interact with clearing house members, usually futures brokers, who pass contracts and margin payments on to the exchange. Clearing house members are directly responsible for initial margin and variation margin requirements at the exchange even if their clients default on their obligations, so they may require more initial margin (but not variation margin) from their clients than is required by the exchange to protect themselves. Since clearing house members usually have many clients, they can net out margin payments from their client's offsetting positions. For example, if a clearing house member has some of their clients holding a total of 900 long position in a contract, and some other clients holding a total of 500 short position in a contract, the clearing house member is only responsible for the initial and variation margin of a net 400 contracts.<ref name=HullP32/>