Futures is a complex financial tool that allows you to trade on the price trend of an underlying asset. It acts as security or collateral for the positions taken. Margins are of many types, but pledge margin is the most common.
One of the key facets of futures trading is the concept of margin. When you use a pledge margin, you agree to lock in a specific value of your holdings with your broker. This value is determined after applying a ‘haircut’, which is a discount to the market value of the securities to account for price fluctuations. The resulting amount is the collateral margin you can use for trading activities, such as equity intraday trading and writing futures & options contracts.
Benefits of Pledge Margin in Futures Market
Here are the main benefits of pledge margin in trading futures.
1. Improved Liquidity
A pledge margin allows you to use your existing securities as collateral to obtain additional funds. That means you do not need to liquidate your positions to meet margin requirements, thus enhancing liquidity and allowing for greater flexibility in trading strategies.
2. Increased Leverage
By using securities as collateral, you can increase your leverage without additional cash outlay.
Suppose you have stocks worth Rs 1,00,000 and want to buy more without selling shares. By pledging these stocks as collateral, you get leverage in a certain ratio such as 5:1.
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3. No Misuse of Securities
In the new pledge system for futures, the securities or stocks that you pledge as collateral are kept in your account. This is a significant advantage as it reduces the potential for misuse of collateralised securities. Unlike the traditional system where the pledged securities were transferred to the broker’s account, the new system ensures that the securities stay in your account, providing an added layer of security and control over your investments.
4. Cost Efficiency
Pledging securities can be more cost-effective than other forms of borrowing. The interest rates on funds obtained through pledge margin via the best brokers are often lower than those on personal loans or credit lines. Also, if you wish to get a loan from a lending institution to place a trade, the process is so tedious that you might lose an excellent trading opportunity.
5. Avoiding Opportunity Cost
Opportunity cost means the potential profit lost when choosing one investment over another. This scenario arises when you sell securities to raise cash in options trading. Under the pledge margin, you can keep your investments and continue to benefit from potential appreciation or dividends.
6. Meeting Margin Calls
In volatile markets, margin calls can occur frequently. Pledge margin provides a quick and efficient way to meet these calls without depositing additional cash, which may not be readily available.
7. Flexibility
Pledge margin provides flexibility to traders by allowing them to use their existing securities as collateral. This means that traders can take larger positions in the market without needing to have the full amount in cash. For example, if a trader has shares in a company, they can pledge these shares and use the value of these shares to trade in futures.
8. Regulatory Compliance
The pledge margin system is designed to comply with regulations set by market regulators like the Securities and Exchange Board of India (SEBI) to protect the interests of traders. This compliance provides a level of protection to both the trader and the broker.
Conclusion
The pledge margin is an essential tool for futures traders. It provides liquidity, leverage, risk management, cost efficiency, and flexibility while ensuring compliance with regulatory standards. Traders who understand and use pledge margin effectively can potentially improve their trading outcomes and achieve financial success. To trade, open an account with Dhan, one of the best broker for option trading and future trading.
