Margining and Liquidations, Part 1: Isolated Margining

Perpetual/futures markets use collateral to back open positions. In this series we’ll analyze the rules governing how collateral is used for margin, and when liquidations occur.

We'll cover isolated margining in Part 1 and cross "additive" margining in Part 2, the two most common methodologies for venues out there. Part 3 covers scenario-based (portfolio) margining, which some venues use to net hedged positions instead of summing them independently. Part 4 is a detailed comparison of how a wide range of top venues actually implement all of this.

Isolated Markets

Let’s start simple. Isolated markets use an independent pool of collateral. Getting liquidated can only erase this pool, not the whole account.

• Equity: the total value of your isolated account, including the collateral you deposited there and the unrealized P&L

  $$\mathsf{Equity}=\mathsf{collateral}\mathsf{balance}+\mathsf{unrealized}P\&L$$

• Maximum Leverage: a parameter, usually depending on the market (e.g. BTC will have higher max. leverage than altcoins), open interest and your open notional (if you have a larger position, you’ll often be allowed less leverage).

• Initial Margin $\mathsf{IM}$: the minimum collateral required to open a position

  $$\mathsf{IM}=\frac{|\mathsf{size}|\times \mathsf{price}}{\mathsf{max}\mathsf{leverage}}=\frac{\mathsf{notional}}{\mathsf{max}\mathsf{leverage}}$$

  For example, if you want to open a position of $\mathsf{notional}=\$10k$ and $\mathsf{max}\mathsf{leverage}=10$, then you’ll need to have a margin of at least

  $$\mathsf{IM}=\frac{\mathsf{notional}=\$10k}{\mathsf{max}\mathsf{leverage}=10}=\$1000$$

  In brief, you can open positions as long as you have sufficient equity: $\mathsf{Equity}>\mathsf{IM}$

• Maintenance MM: the minimum collateral required to not get liquidated. The formula is the exact same as the IM, except the max leverage will be generally higher.

  For example, if you start with the position above, with $1000 of margin, and the maintenance leverage is 20, then you’ll only be liquidated if you margin falls below

  $$\mathsf{MM}=\frac{\mathsf{notional}=\$10k}{\mathsf{max}\mathsf{leverage}=20}=\$500$$

  Of course, you can also be liquidated if price rallies (thus increasing notional) or market parameters change reducing leverage.

  In brief, you get liquidated once your equity falls below maintenance: $\mathsf{Equity}<\mathsf{MM}$

Closing

And that’s it! Now you understand how isolated markets work. Feel free to read Part 2 for cross margining, which is a generalization of isolated margining.