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Variation Margin: Summary
Variation Margin - Definition
Variation Margin is additional amount of deposit you need to make to your trading account in order to maintain sufficient money for loss deduction after significant losses have taken place.
Variation Margin - Introduction
Variation Margin, also known as Mark To Market Margin, is additional amount of cash you are required to deposit to your futures trading account after your futures position have taken sufficient losses to bring it below the "Maintenance Margin". Futures traders are typically required to provide variation margin through "Margin Calls".
This free tutorial shall explain in depth what Variation Margin is, how it is calculated and how it affects your futures trading. Read the full tutorial on futures margin.
What is Variation Margin in Futures Trading?
Variation Margin is one of three margin terms that all futures traders must understand. The other two being Initial Margin and Maintenance Margin. Variation margin derived its name from the fact that the amount of variation margin varies from case to case. Despite the fanciful name, variation margin is simply an amount of money needed to bring your margin balance back up to the inital margin level (not maintenance margin level) after sufficient losses have brought it below the required Maintenance margin level. Yes, variation margin in futures trading is simply topping up your futures account with more cash so that future losses can be deducted from.
As you can see from the example above, the variation margin varies according to the amount of money you need to pay to bring your futures margin account back up to the initial margin level.
When Do You Pay Variation Margin?
You will be notified to provide variation margin whenever your margin balance goes below the maintenance margin level during the daily settlement or mark to market process. In futures trading, this process happens daily at the close of each trading day. When this happens, your broker gives you a notification known as a "Margin Call" telling you exactly how much cash needs to be provided in order to meet variation margin requirement. If you have sufficient cash remaining in your futures trading account, the cash needed to meet Variation Margin requirement will be automatically deposited.
So, what if you do not have sufficient cash to meet variation margin requirement?
If you do not have enough cash to pay for variation margin, your futures trading position will be forcefully liquidated by your broker. This means that your futures broker will close your position with whatever loss it has sustained so far.
How is Variation Margin Determined?
You are required to provide Variation Margin only when your margin account drops below the maintenance margin level. This level is different for each asset and/or market and is one of the pieces of information you must know before deciding to trade a particular futures contract. Once your margin account drops below the maintenance margin level, variation margin is determined by the amount of cash needed to bring your account back to the initial margin level.
Therefore, the formula for Variation Margin is:
Variation Margin = Initial Margin - Margin Balance
Purpose of Variation Margin
The purpose of variation margin is to make sure your margin balance remains liquid enough for future losses to be deducted from. This is one of the clearinghouse's way of ensuring that every futures contracts are fulfilled. Yes, clearinghouses guarantee the performance of every futures contract and the entire futures margin system is the clearinghouses' way of lowering their risk of making such a guarantee. Without variation margin and the futures margin system, clearinghouses would go bankrupt in express time due to longs and shorts defaulting on their futures trading losses which then have to be made up by the clearinghouses.