The variation margin is an essential margin payment that clearing members, such as futures brokers, make to their respective clearing houses. This margin is determined based on adverse price movements of the futures contracts these members hold. Variation margin is paid daily or intraday to mitigate exposure from high-risk positions. By enforcing variation margin requirements, clearing houses maintain suitable risk levels, enabling orderly payment and receipt of funds for all traders associated with that clearing house.
Key Takeaways
- Variation margin refers to funds needed to maintain required margin levels for trading.
- It depends on factors like expected price movements, asset type, and market conditions.
Basics of Variation Margin
Variation margin is used to ensure that an account’s capital remains at an appropriate margin level. This margin, along with the initial and maintenance margins, must be supported by liquid funds that act as collateral against possible losses from ongoing trades.
For example, if a trader buys a futures contract with an initial margin of $3,000, they need to maintain this amount in their account. The maintenance margin for this contract might be $2,500. If the account balance drops below $2,500, the trader needs to top up the account to $3,000, as the $500 loss has reduced the capital buffer to an insufficient level. The amount needed to bring the account back to an acceptable level is known as the variation margin.
In practice, a broker with numerous traders in various positions must account for all these positions and submit funds to cover the risks taken by their trades to the clearing houses.
The amount of variation margin required fluctuates with market conditions and daily price movements. When the equity account balance falls below the maintenance or initial margin requirement, the broker may call for additional funds, known as a margin call.
Margin Call
A margin call is triggered when a broker requires an investor to deposit additional funds to meet the minimum margin amount. This happens when the account incurs losses or additional positions are acquired, causing the equity balance to dip below the required minimum. If the investor cannot fulfill the margin call, the brokerage can sell securities in the account to meet the margin requirements and reduce risk.
Maintenance Margin Requirement
Maintenance margin refers to the minimum balance an investor must keep in their margin account when trading stocks. It is typically lower than the initial margin required for trades, providing a buffer for the investor to borrow from the brokerage.
The Financial Industry Regulatory Authority (FINRA) mandates that the maintenance margin for stocks be set at a minimum of 25%. However, brokers can set higher minimums, such as 50%, based on the perceived risk and the investor’s profile.
In futures trading, the maintenance margin is the level at which an investor must replenish their account to the initial margin amount.
Example of Variation Margin
Imagine a trader buys 100 shares of stock ABC at $10 each. The broker’s initial margin for the purchase is 50%, meaning the trader must maintain $500 in the account for trading. If the maintenance margin is set at $300, a price drop in ABC to $7 results in a $300 loss.
The initial margin account balance falls to $200, which is below the $300 maintenance margin. With the new initial margin requirement being $350 (50% of $700), the trader must add $150 to the account to continue trading.
Related Terms: initial margin, maintenance margin, margin call, collateral, clearing member, clearing house
