MTM Mark to Market  in Futures Trading

The daily price fluctuations in futures can lead to either profits or losses. Mark to market (M2M) is employed to adjust the gain or loss accordingly and grant it to you while the contract is held. To illustrate, let’s examine a straightforward example.

Assume on 1st Dec 2014 at around 11:30 AM; you decide to buy Hindalco Futures at Rs.165/-. The Lot size is 2000. 4 days later, on 4th Dec 2014, you decide to square off the position at 2:15 PM at Rs.170.10/-. Clearly, as the calculation below shows, this is a profitable trade –

Buy Price = Rs.165

Sell Price = Rs.170.1

Profit per share = (170.1 – 165) = Rs.5.1/-

Total Profit = 2000 * 5.1

= Rs.10,200/-

The trade lasted 4 working days, with each day’s profits or losses being marked-to-market against the previous day’s closing price.

We can analyse the performance of M2M by examining the table above, detailing the futures price movement over its four-day duration. By looking at changes daily, we can gain insight into how this process operates.

The futures contract was bought at Rs.165/- on Day 1 at 11:30 AM and closed at Rs.168.3/-, resulting in a profit of Rs.3.3/- for each share. Since the lot size was 2000, a total gain of Rs.6600/- was earned.

This means that, through the broker’s services, your trading account will be credited with Rs. 6600/- at the end of the day.

1. Where is the funding for this project being sourced?
   1. It is clear that the counterparty must compensate their loss of Rs.6600/-, with the exchange guaranteeing payment.
2. But how does the exchange guarantee that the money is received from the individual with an obligation to pay?
   1. When beginning a trade, one must consider the deposited margins. We will cover more on this later. 

It is important to note that from an accounting point of view, the buy price for futures is no longer seen as Rs. 165 but rather Rs. 168.3 (the closing price of the day). You may be wondering why this is so – since the profit earned for the day has already been credited to your trading account, it’s a new beginning in terms of profits and losses. That’s why the buy price is marked at the closing rate of Rs. 168.3 on that particular day.

On day 2, the futures closed at Rs.172.4/- and made investors a profit of Rs.4.1/- per share or a net total of Rs.8,200/-. After this amount is credited to their trading account, the buy price is reset to the closing rate for that day which stands at Rs.172.4/-.

On day 3, the futures closed at Rs.171.6/-, representing a decrease of Rs.1600 /- over yesterday’s closing price (172.4 – 171.6 * 2000). This amount will be automatically deducted from your trading account and your buy price is now reset to Rs.171.6/-.

On day 4, despite holding the position until 2:15 PM, the trader decided to square off at Rs.170.10/. As a result, he made a net loss of Rs.1.5/- per share and Rs.3000/- (1.5 * 2000). After doing so, any future movement in price was irrelevant and his account reflected the total debit of Rs.3000/- by the end of the day.

Let’s calculate the worth of our daily mark-to-market and take a look at how much money has been earned and spent.

Adding together all the M2M cash flow gives us the same sum we first calculated –

Buy Price = Rs.165/-

Sell Price = Rs.170.1/-

Profit per share = (170.1 – 165) = Rs.5.1/-

Total Profit = 2000 * 5.1

= Rs.10,200/-

So, the mark to market is just a daily accounting adjustment where –

1. The amount of cash deposited or withdrawn is contingent on the futures market’s movements. This is known as a daily obligation.
2. Yesterday’s closing price is used to figure out the today’s M2M.

What is the purpose of M2M? It’s a daily cash adjustment, which significantly reduces the risk of counterparty default. As long as the trader is in possession of the contract, this process ensures both sides are given a fair and just outcome each day.

Returning to margins, let’s observe the development of trade during its lifespan.