WHAT IS MARK-TO-MARKET (M2M) IN FUTURES CONTRACT?

Posted by Advisorymandi on May 14th, 2019

If you’re trading in the futures market, then you must know about margins giving it plays a major role in the futures trading. However, there is one thing that not all futures traders are familiar i.e. mark-to-market (M2M). Mark to market also known as marking to market which is a financial term of a process involved adjusting of profit or loss of assets covered in a futures contract at the end of each trading day.      

The purpose of using the mark to market is to determine the overall profit or loss made each trading day. That’s why it has a big influence in futures trading. You can also call it ‘daily settlement’ of underlying asset under a futures contract.

When trading in stock futures, it is important to be making yourself familiar with mark to market since it helps in identifying the overall profit and loss made each trading day. You can think of it as another one of the stock tips.  

Marked-to-Market (M2M)

Let’s take an example to better understand this:

Let’s suppose you are ready to buy the Tata Motors Futures on 13^th May 2019 at around 12:00 PM at Rs. 180.00. The lot size of Tata Motors Futures is 2000. 4 days later on 16^th May 2019 you decide to square off your position at 02:45 PM at Rs. 185.00.

Seeing this, it is clear that it is a profitable trade and calculation below shows –

Buy Price = Rs. 180.00

Sell Price = Rs. 185.00

Profit per share = Rs. (185 - 180) = Rs. 5.00.

Total profit = 2000 * 5 = Rs. 10,000.

Now, the trade was held for 3 working days. Each day the futures contract is held, the profit or loss is marked to market. So, in order to calculate the profit or loss, the closing price of each day will be considered and used as a reference to calculate the profit or losses.

Now let us know what happens on a day-to-day basis to understand how M2M works in futures contract –

On Day 1: Rs. 2000*(183.30 – 180.00) = Rs. 2000*3.30 = Rs. 6,600.00.

The exchange will ensure that Rs. 6600 get credited to your trading account at the end of the day. In doing so, the exchange will also ensure that the counterparty will pay the loss of Rs. 6600.00.

On Day 2: 2000*(186.5 – 183.3) = Rs. 2000*3.20 = Rs. 6400.00.

Now like Day 1, the profits that you entitled to receive will get credited to your account and buy price will once again set to the day’s closing price.

On Day 3: On the third day, the futures closed at Rs. 186.00 which means compared to the previous day close, it is a loss of (186.5 – 186.0)*2000 = Rs. -1000.00. Now the lost amount will be automatically debited from your trading account.

On Day 4: On the 4^th day the trader decided not to continue holding his position throughout the day but rather decided to square-off at 2:45 PM at Rs. 185.00. With respect to the previous day’s close, the trader made a loss of Rs. 2000.00 (186 -185)*2000 = Rs. 2000.00. So, it doesn’t matter if the futures closed below or above the figure at which the trader squared-off his position.

Now tabulate the daily marked-to-market and see how much money he won or lost –

If we summed up all the M2M cash flow then the profit will be of the same amount that we originally calculated –

2000*(185.00 – 180.00) = 2000*Rs. 5 = Rs. 10,000.00/-

So, the M2M (mark-to-market) is just a daily accounting adjustment in stock futures where the money is credited or debited on the behavior of futures prices.

Hope, this article helped you in the understanding of mark to market. Nevertheless, if you have any query or would suggest anything that we missed then please don’t forget to mention in the comment section below.