Futures trading is part of derivatives trading and only experienced traders who have understood the stock market and derivative market really well are suited for trading in this segment. 

As futures trading has a lot of risks as it is leveraged and price moves really quickly, it is crucial for anyone to understand how trades are valued and settled.

So the key aspect of futures trading is the concept called mark-to-market which is also known as MTM. This concept determines how much is your daily gains and losses and how much margin is needed. In this blog, we will discuss MTM and why it matters and how it can influence your trading strategy. 

What Is MTM?

Buying stocks is different from buying futures contracts because when you buy a stock, you buy at market price, whereas when you buy a futures contract, it is a leveraged transaction and for that reason it is important to calculate mark-to-market. 

Any futures contract that is open is evaluated based on the market’s current price of the underlying asset at the end of each trading day. This evaluation and revaluation every day till the contract is exited or expires reflects the current settlement price of the underlying asset for the specific futures contract. The underlying asset can be stock, commodities like gold, crude oil, etc. 

When this daily revaluation is done, your profits or losses are updated regularly in your holdings. The unrealized profit or loss is calculated by the difference between your entry price of the contract and today’s market price. 

If the market moves in your favor, then the money is credited to your account and if it moves against your expectation then the funds are deducted. 

How MTM works

Let us look at how MTM works with an example for better understanding

Let’s assume you buy Nifty Futures at Rs 24,000 and the lot size is 65

Notional value = 24,000 × 65 = Rs 15.60 lakhs

Day 1: Price goes to Rs 24,140

Gain = 140 × 65 = Rs 9,100

Your MTM account is credited with Rs 9100 and your margin balance increases.

Day 2: Price falls to Rs 23,900

Loss = 240 × 65 = Rs 15,600

Rs 15,600 is debited from your MTM account.

Day 3: Price increases to Rs 24,100

Gain = 200 × 65 = Rs 13,000. Your account is credited with this amount and your holdings are updated with the new balance. 

Importance of MTM

Mark-to-Market (MTM) plays an important role in the futures market to keep things fair and straightforward and also reduce any risks associated with it. 

MTM helps in minimizing counterparty risk as positions are settled on a daily basis on current market price. As a result, neither party is left exposed to large losses if the other fails to meet their obligations.  

It also brings transparency as traders will get a clear picture on how their open positions are performing, reflecting real-time market conditions everyday. This helps all the market participants and stakeholders to stay informed about current trends in the market.  

MTM helps market participants with better margin management. In capital markets, your open positions will fluctuate and MTM tracks unrealized gains or losses. If your losses increase and your account cannot cover the losses, you’ll get a margin call from your broker to maintain your. This is precautionary and it informs the traders to either add more funds or close the losing trades before things get worse. This is to make sure that there is enough margin to cover losses on a daily basis and not on expiry. 

Daily updates through MTM will encourage traders to be active and track their holding regularly. With real-time profit and loss visibility, traders are more likely to stay engaged, review their strategies and twerk if need be and decide whether to hold, adjust, or exit positions. 

Things to remember regarding MTM

MTM is a daily settlement process that must be calculated and it is mandatory. It ensures that positions are valued based on current market prices every day. 

If a trader experiences significant losses, a margin call will be issued by the broker as per the rules of the regulator and the trader must bring the required margin to hold their position. On the other hand, if there are any gains then the gains are automatically added to your margin balance, improving your available funds. 

The MTM calculation is continued until the position is closed or the contract has expired. Overnight market fluctuations will have an impact on the MTM calculation and it is reflected the next morning. 

Conclusion

Mark-to-market (MTM) is an important aspect of trading as it improves transparency while trading and helps traders to manage their margins cautiously. Due to MTM, investors are able to evaluate their position and adjust their holdings to book profits or minimize losses. By understanding the workings of MTM you can trade in the futures segment with more clarity and confidence, and stay on track.