There has been intense
interest from traders, regulators and politicians related to the performance in
some commodities, particularly silver. In response, the margin
requirements to hold some futures contracts, again particularly silver, have
Exchanges supposedly set
their margin requirements using computer algorithms based on historical and
implied volatility, but the fact of the matter is that the ultimate decision is
discretionary...and they are not immune to political pressure.
The question now isn't
whether margin requirements on silver are going up - they already have,
astronomically - the question is what impact it will have going forward.
What kind of dent in
sentiment does such a hike tend to have?
historical margin requirements has proved to be exceptionally difficult. I
have about 10 years' worth for most commodities, but only 7 for silver.
It's not for lacking of trying, or expense.
Assimilating all the
research, the conclusion boils down to this:
Margin increases tend to
greatly lower trading volumes and open interest, and they stabilize price action
to where it was before the event that triggered the margin change. That
holds especially true in markets like silver where speculators are a larger
None of the studies
suggested that price action itself was consistently impacted by margin changes.
It was only trading volume and open interest that were influenced in
statistically significant way.
The chart below shows
silver futures, along with the initial margin requirement for speculators, which
obviously has gone parabolic. Aggregate open interest has, true to
historical precedent, fallen during that time.
One potential difference
this time is that the studies are based on the idea that speculators in silver
futures are "jump on the bandwagon" types. But based on data from the CFTC,
we're not seeing that this time. Large speculators are not that net long
the futures, and didn't ramp up their exposure as it rose (possibly due to the
introduction of exchange-traded funds that are easier and more liquid than
The ETFs may throw a
wrench into what the exchanges are trying to do, but historically these margin
hikes have led to lower volume and lower volatility. For those who are
suggesting that it necessarily means a decline in silver, they may have a
point...but it's not supported by any empirical research that I can find.
Silver prices will fluctuate based on their own merit, and not based on
arbitrary margin requirements.
For those who want more
detail, here are the relevant conclusions from the two most topical studies:
"In summary, there is
strong evidence that (1) the exchange used margin requirements to affect market
activities; (2) margins were usually raised if the trading pattern had been
heavy; and (3) except for the open interest in the 1979-1980 period, changes in
margin requirements were effective in stabilizing the trading pattern prevalent
prior to the change."
- Margin Requirements
and the Behavior of Silver Futures Prices, Christopher K. MA, G. Wenchi Kao and
"There is a clear causal
negative margin effect on trading volume and open interest. Trading activity
moves away from...the metal with the higher...margins. [a]10 percent
increase in margins is associated with a drop in average trading volume of 1.38
percent, a drop in average open interest of 1.51 percent, and a drop in the
growth rate of open interest of 2.96 percent."
- Margin Requirements,
Price Fluctuations, and Market Participation in Metal Futures, Journal of Money,
Credit & Banking, Gikas Hardouvelis and Dongcheol Kim
Hardouvelis and Kim
(1995) examine metals futures contracts. They exclude silver contracts during
the Hunt Brothers squeeze period arguing that the special circumstances of the
period would contaminate their sample.
They found strong evidence
that high metals futures margins reduce contract open interest, but no evidence
that higher margins attenuate contract price volatility. Indeed their evidence
suggests that any empirical margin-volatility relationship in the data owes to
the prudential activities of the futures clearinghouses. Higher volatility leads
the clearinghouse to increase margins, but the increase in margin has no
measurable effect on contract price volatility subsequently.