Variation Margin

Variation Margin — Definition and Key Takeaways

Variation margin is the payment made to cover daily (or intraday) changes in the market value of a trade. It represents the cash or collateral required to settle gains and losses as positions are marked to market, and it is used primarily by clearinghouses and brokers to limit counterparty credit risk.

Key points:
* Variation margin covers realized changes in value (daily P&L) and keeps margin accounts at required levels.
* It is distinct from initial margin (the upfront collateral required to open a position).
* Failure to meet a variation margin call can result in forced liquidation of positions.
* Variation margin is common in futures, derivatives, and cleared OTC markets, where positions are settled through a clearinghouse.

How Variation Margin Works

1. Positions are marked to market (valued at current market prices) regularly—often daily or intraday.
2. If the marked value of a position produces a loss, the party with the loss must pay variation margin to the counterparty or clearinghouse.
3. If the position produces a gain, that party receives the corresponding variation margin.
4. The clearinghouse or broker uses these payments to keep all counterparties’ collateral at required levels and to prevent the build-up of unsecured losses.

This process reduces credit risk by ensuring losses are covered as they occur, rather than accumulating.

Initial Margin vs. Variation Margin

• Initial margin: Collateral posted when a trade is opened. It protects against potential future exposure while a position is active.
• Variation margin: Ongoing payments reflecting actual changes in market value (realized gains or losses) since the last settlement.

Both work together to maintain market integrity: initial margin covers potential future movements, while variation margin covers realized movement.

Maintenance Margin and Margin Calls

Maintenance margin is the minimum equity that must be maintained in a margin account. When an account falls below this level because of losses, a margin call is issued requesting funds to restore the account to the required level (often up to the initial margin).

What happens on a margin call:
* The broker or clearinghouse requests additional funds (variation margin).
* If the required funds are not posted, the broker may liquidate positions to reduce risk.
* Margin requirements vary by asset, broker, and regulator (for example, regulators set minimums, but brokers can set higher levels).

How Variation Margin Is Calculated (General)

Exact calculations vary by contract and clearinghouse, but the basic idea is:

Variation margin due = Change in marked-to-market value (loss) since last settlement

Or stated another way:

Variation margin = Required margin level (after mark-to-market) – Current margin balance

In practice, exchanges and clearinghouses calculate daily P&L for each position and issue a payment or credit reflecting that P&L.

Example

A simple illustrative example for an equity position:
* Trader buys 100 shares at $10 = $1,000 position.
* Broker requires 50% initial margin = $500 posted.
* Maintenance margin is $300.
If the stock falls to $7:
* Position value = 100 × $7 = $700.
* Loss = $300 (from $1,000 to $700).
* Margin account balance after losses = $500 − $300 = $200, which is below the $300 maintenance margin.
* The trader receives a margin call (variation margin) to add $100 to bring the account back to the $300 maintenance level (or to the initial margin as required).

For futures and cleared derivatives, variation margin is typically calculated and settled daily using the exchange’s mark-to-market process.

Role of Clearinghouses

Clearinghouses act as intermediaries between buyers and sellers in cleared markets:
* They guarantee trades by novating contracts (becoming the buyer to every seller and seller to every buyer).
* They collect initial margin and variation margin to manage default risk.
* They perform daily settlement (mark-to-market) and issue margin calls accordingly.

Practical Considerations

• Variation margin requirements can be intraday in volatile markets.
• Different asset classes and contracts have different margin rules and thresholds.
• Brokers may set higher margin requirements than regulatory minimums.
• Traders should monitor margin balances closely to avoid forced liquidations.

Conclusion

Variation margin is a core risk-management mechanism in leveraged and cleared markets. By settling gains and losses regularly and requiring parties to top up collateral when needed, variation margin helps maintain market stability and reduces counterparty credit risk. Understanding how variation margin interacts with initial and maintenance margin is essential for anyone trading marginable or cleared instruments.