There has been a lot of confusion over the announcement by the CME to increase the margin on silver futures contracts by 30 percent. Several articles have claimed that it was the cause of the recent sell off in silver because it forced buyers to cover their positions. This notion is completely false, and in fact the market would be better off with higher margins.
While a 30 percent increase in margin requirements sounds like a lot, the truth is that the increases was $1500 per contract where each contract is currently valued at $136,500. On the day that the price of silver was up over $1, the margin maintenance was increased by 30 cents. This means that no long holder would have had to put up any more money (until the selloff) and any investor that was holding long positions from before September is still holding gains of $8 per contract. If anything, raising margin requirements should have squeezed short positions more since the price has increased substantially in recent weeks.
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Even now, the margin requirements of silver are 4.7 percent of the contract value. That means that a trader’s equity will be completely wiped out in a 4.7 percent move. Professional metals traders are well aware that this is too low of a margin and any successful trader will hold much more capital per contract than required. The result is that investors self-impose their own higher margin requirements by reducing leverage far below the theoretical exchange defined requirement.
Margin requirements should be higher on silver contracts, especially for short sellers because silver has already increased by more than 5 percent in a day and is at risk of gapping higher at any time. This introduces the risk of default by a large trader that fails to meet margin requirements and makes the entire exchange less stable. Exchange risk is not priced into the precious metals markets, however it eventually will be when it is understood that the probably of default is approaching 100 percent. The margin increase is a reminder that the exchange can and will change the rules when commercial shorts are squeezed into default.
