How to calculate the contract liquidation price?

In futures trading, when account equity drops below the maintenance margin, the liquidation price determines at which price open positions are closed to mitigate losses.

Oct 08, 2024 at 10:33 am

How to Calculate the Contract Liquidation Price

In futures trading, liquidation occurs when a trader's account equity falls below a certain threshold, known as the maintenance margin. When this happens, the broker will automatically close out the trader's open positions to recover the losses. The liquidation price is the price at which the positions are closed out.

Here's how to calculate the contract liquidation price:

1. Determine the Maintenance Margin

The maintenance margin is typically a percentage of the total value of the open positions. The exact percentage varies depending on the broker and the underlying asset.

Example: If the maintenance margin is 20% and the total value of the open positions is $100,000, then the maintenance margin would be $20,000.

2. Calculate the Equity

Equity is the difference between the total value of the open positions and the total margin (initial margin + maintenance margin).

Example: If the total value of the open positions is $100,000 and the maintenance margin is $20,000, then the equity would be $80,000.

3. Determine the Liquidation Price

The liquidation price is the price at which the broker will close out the trader's positions to recover the losses. It is calculated using the following formula:

Liquidation Price = (Maintenance Margin / Equity) * Total Value of Open Positions

Example: If the maintenance margin is $20,000, the equity is $80,000, and the total value of the open positions is $100,000, then the liquidation price would be:

Liquidation Price = (20,000 / 80,000) * 100,000 = $25,000

This means that if the price of the underlying asset falls below $25,000, the broker will close out the trader's open positions and liquidate the account.