A variation margin is a type of margin payment used in financial markets, specifically in futures, options, and other derivatives trading, to cover the changes in the value of an open position resulting from daily price fluctuations.
The purpose of the variation margin is to ensure that the parties involved in a trade maintain sufficient collateral in their margin accounts to cover potential losses and prevent default on their obligations.
In derivatives trading, such as futures and options contracts, the value of a position changes daily due to market price movements.
The variation margin is calculated at the end of each trading day based on the settlement price, which is the official closing price of the contract.
If the value of the position has increased, the party with the profitable position receives a variation margin payment from the counterparty who has suffered a loss.
This payment process is called “marking to market,” as it ensures that the value of the position is updated daily and reflects the current market price.
The variation margin helps to manage the credit risk associated with derivatives trading by ensuring that parties involved in the trade maintain sufficient capital to cover potential losses.
It also provides a mechanism for the regular transfer of profits and losses between the parties, reducing the risk of a default on the contract’s obligations.
It’s important to note that variation margin is different from the initial margin, which is the upfront collateral required when opening a derivatives position.
While the initial margin serves as a security deposit to cover potential future losses, the variation margin reflects the daily changes in the value of the open position.
