What Is Variation Margin?
Let me explain variation margin directly: it's a variable payment you make to a clearing house when your collateral as a clearing member loses value. You pay this on a daily or intraday basis to cut down on the exposure from holding high-risk positions. By collecting these payments, clearing houses keep risk at a manageable level, ensuring smooth payments and receipts for all traders involved.
Key Takeaways
Remember, variation margin is what you pay when your collateral drops in value. It's essential for keeping margin levels sufficient for trading. The amount depends on expected price movements, the type of asset, and current market conditions.
Understanding Variation Margin
Variation margin brings your account capital up to the required margin level. This, along with initial and maintenance margins, must be backed by liquid funds to act as collateral against potential losses from ongoing trades.
For instance, if you buy one futures contract with an initial margin of $3,000 and a maintenance margin of $2,500, dropping below $2,500 means you need to add funds back to $3,000. That added amount is the variation margin, covering the $500 loss that reduced your buffer.
Now, consider a broker handling thousands of traders with varying positions—some winning, some losing. The broker, as the clearing member, accounts for all these and submits funds to the clearing house to cover the overall risk.
The variation margin amount fluctuates with daily market conditions and price changes. If your equity falls below maintenance or initial margin, your broker may issue a margin call for additional funds.
Margin Call
A margin call is when your broker demands more funds to meet the minimum margin. This happens if your account loses money or you add positions, dropping equity below the required level for those holdings. If you can't meet it, the broker can sell your securities until the margin is satisfied or risk is lowered.
Important Note
Variation margin applies to both derivatives and futures trades.
Maintenance Margin Requirement
Maintenance margin is key in calculating variation margin—it's the minimum you must keep in your margin account for stock trading, usually less than the initial margin, allowing borrowing from your brokerage as collateral.
FINRA sets a minimum of 25% for stocks, but brokers might require more, like 50%, based on risk and investor profile. For futures, it means the point where you must top up to the initial margin amount.
Example of Variation Margin
Suppose you buy 100 shares of stock ABC at $10 each, with a 50% initial margin from your broker, requiring $500 in your account. The maintenance margin is $300.
If ABC drops to $7, you lose $300, leaving your initial margin at $200—below the $300 maintenance. The new initial margin is $350 (50% of $700), so you need to add $150 to continue trading.
What Is Initial Margin and Variation Margin?
Initial margin is the minimum collateral you pay before starting a derivatives contract, while variation margin is the ongoing payment adjusting for changes in the underlying asset's market value.
What Does a Clearinghouse Do?
A clearinghouse acts as an intermediary, finalizing trades between buyers and sellers, collecting margins, and regulating asset delivery post-trade.
How Is Variation Margin Calculated?
The formula varies by contract and asset, but generally, it's Initial Margin minus Margin Balance. It factors in initial and maintenance requirements plus the current security value.
The Bottom Line
Variation margin is one of two collateral types reducing margin trading risk. In derivatives and futures, you may need periodic payments when collateral value drops.
Other articles for you
A syndicated loan is financing provided by a group of lenders to a single borrower to spread risk on large-scale projects.
The standard deduction is a fixed amount that reduces taxable income, offering a simpler alternative to itemizing deductions for US taxpayers.
A relationship manager improves business relationships with clients and partners to enhance value and reputation.
Profit before tax (PBT) measures a company's earnings before deducting taxes, highlighting its pre-tax profitability.
Debtor-in-possession (DIP) financing provides companies in Chapter 11 bankruptcy with priority loans to continue operations and reorganize.
Painting the tape is an illegal market manipulation tactic where traders artificially inflate trading volume to lure investors and drive up stock prices.
Present value estimates the current worth of future money to aid investment comparisons.
The Kellogg School of Management is a prestigious graduate business school at Northwestern University offering top-ranked MBA programs with a global focus.
Form 1099-Q reports distributions from qualified education programs like Coverdell ESAs and 529 plans for tax purposes.
Gross National Income (GNI) measures a nation's total income from residents and businesses, including foreign sources, providing a broader view than GDP.