Mandatory margin?! Featuring derivatives contracts
marginfi is a decentralized margin protocol for trading across Solana. The protocol makes it easy for traders to access margin, manage risk, and improve capital efficiency across the entire Solana ecosystem from one unified place.
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This article is a continuation of the marginfi Leverage (learning) series.
Hello, traders! We previously had a discussion on how trading on margin is different from borrowing, and we pointed out that margin is not always optional. Today’s article is meant to explain why, and how margin is used in different ways. Let’s dive in.
When we first described margin, we talked about how trading on margin refers to borrowing money to buy financial assets. When an asset is purchased on margin, part of the price is paid by the trader (margin), and part of the price is paid via the margin loan. The asset that was purchased is held as collateral for the margin loan. This is commonly used when a trader wants exposure to a vanilla asset.
It turns out there is another way margin is used. When a trader enters into a contract that features an obligation to a counterparty, margin is used as a deposit to help ensure that the trader can make good on their obligation. This is common in futures contracts and certain options positions.
Without delving too deep into futures contracts, they represent a contract between two parties — one party takes the long side of a trade and one party takes the short side of a trade. When the underlying asset specified by a futures contract moves up in price, the counterparty on the long side of the trade is entitled to a payment made by the counterparty on the short side (and vice-versa).
Since each party to a futures contract might have to pay the other party depending on where the price goes, it’s important to make sure both sides are able to pay. That’s where margin comes in. When a trader enters a futures contract they are not exchanging money initially. Instead they deposit a fraction of the notional value of the contract into their margin account.
Like futures contracts, options contracts feature an obligation to a counterparty. However with options, only one side of the options trade carries the obligation.
Call options feature the right, but not the obligation, to buy an asset for a certain price at (or before) the time of expiration. By opening a short call position, a trader becomes the counterparty who has an obligation to sell the asset if the option is exercised. For taking on this obligation they are compensated by being paid a premium.
In order to guarantee that the option writer can make good on the possibility that they have to sell the asset, they must either deposit the underlying asset in a margin account or (depending on the contract) deposit cash to serve as collateral.
On the other side of the coin, put options feature the right, but not the obligation, to sell an asset for a certain price at (or before) the time of expiration. In the same way, by opening a short put position, a trader becomes the counterparty who has an obligation to buy the asset if the option is exercised — and they are compensated for doing so. This means that the seller of a put option must make a deposit to show that they are able to purchase the underlying.
So why do we talk about margin when referencing assets traded on leverage and when trading derivatives? Well, they’re not so different. Derivatives positions generally expose a trader to outsized risk and return relative to the amount of capital they have to deposit in a margin account. Margin on derivatives is also subject to initial margin and maintenance margin requirements.
Let’s make it real by checking out some examples on Solana.
Mango Markets is a spot and perp-futures DEX. One of the products featured on Mango is a SOL/USDC perpetual futures contract.
If you deposit $200 USDC into your Mango Markets account, the protocol will allow you to take out up to $2,000 worth of perpetual futures exposure (10x leverage).
You can read more about Mango’s leverage calculations here.
Drift is also a perp-futures DEX offering SOL/USDC (and other pairs). The display of information is slightly different, but the concept is the same.
After depositing USDC into your Drift account, you can open a position with up-to 5x leverage, and you must maintain at least 6.25% margin requirement (16x leverage ratio) to avoid partial liquidations.
PsyOptions is an American style options protocol on Solana. Here we can see the collateral required to sell a Dec 31 BTC/USDC put option is $500 USDC.
Recall in the explanation earlier that short put positions involve an obligation to buy the underlying asset if the option is exercised.
Eyeing the horizon
As you can see, there are a number of ways to trade with leverage. Each method for gaining outsized price exposure (through spot, futures, and options products) has their own margin requirements and those requirements can vary based on the DEX logic.
Things get more complicated when considering how margin works in an account with multiple positions. The way this is handled is through cross-margining, which we’ll explain soon.
As always, no marginfi content should ever be considered financial advice and no reference to financial assets, securities, derivatives, or other financial products should be considered an endorsement of the aforementioned. Please consult a licensed financial advisor before making any and all investment decisions, and please do your own research.