Fundamentals of A Margin Call: Variation Margin vs Initial Margin

Other brokerages can set higher minimums, such as 50%, depending on the level of risk and the investor involved. Variation margin is the difference between the initial margin requirement required to open the trade and the amount required to keep the position open once the market moves. Initial margin is a risk-based calculation, while the variation margin calculation is based on the market values of trades. The winner and loser of the trade can shift at any time, triggering variation margin payments from either participant of the trade. A party only has exposure to the other if the market value of derivatives contract moved in its favor.

1. If the capital drops from the required level, the broker must add the difference to return it to acceptable levels.
2. At the end of each trading day, the clearinghouse, acting as an intermediary, revalues derivative contracts based on the prevailing market prices.
3. With that said, margin trading can potentially yield significant returns for investors, though it has more risks than traditional trading.
4. It is an important factor in calculating variation margin, as it sets the threshold at which a margin call will be made.
5. They can use whatever model they want to calculate initial margin, as long as it meets certain criteria and gets regulatory approval.

Understanding NAV: Calculation, Market Impact, and Fund Types

At the end of the trading day, the contract’s value rises to Rs 15 due to market movements. In this scenario, the trader would receive Rs 5 as a variation margin credit. Conversely, if the contract’s value dropped to Rs 98, the trader would owe Rs 2 as a variation margin.

Variation Margin: Derivatives Market Safety Net

Maintenance margin is an important factor to consider while calculating variation margin. It refers to the amount of money an investor must keep in his margin account when trading stocks. This margin functions as collateral against the amount borrowed by the investor. Several factors influence the calculation of variation margin, including the volatility of the underlying asset, the size of the position, and the collateral held. Understanding these elements will help traders predict potential margin calls and manage their positions more effectively. In my experience, closely monitoring market volatility and adjusting my positions accordingly has allowed me to maintain a stronger grip on my trading outcomes.

Suppose Trader A enters into a futures contract for 100 shares of Company X at a price of Rs 200 per share. Collateral management is not just about posting and receiving margin; it also involves the efficient transfer and settlement of these assets. The operational infrastructure supporting variation margin includes custodians, clearinghouses, and settlement systems.

Traders should always consider both types of margins when developing their plans, as they directly impact risk exposure and available leverage. Position sizing, for example, should factor in both margins to protect against potential calls effectively. As a seasoned trader, I often encounter questions surrounding the concept of variation margin. It is crucial to understand this concept not only for compliance but also for effective trading strategies.

Her work has been published on sites like Quicken and the crypto exchange Bybit. Variation margin covers any losses that occur because of changes in the value of the underlying asset. Calculation of the variation margin involves straightforward arithmetic based on these marked-to-market changes. Understanding the intricacies of variation margin is essential for financial professionals who aim to navigate these complex waters effectively. This helps guarantee both parties have adequate collateral throughout the life of the trade. Because of this, internal margin models may differ significantly, making it possible for two firms to get significantly different initial margin figures for the same 25 forex trading strategy videos and articles in 2021 trade.

However, brokerage firms have separate rules, fees, and margin requirement percentages. The realized variation margin is the amount of money that is paid or received when a position is closed out. Based on your exposure to the bank and its risk profile, after using your internal model in line with the SIMM, you arrive at the initial margin the bank should post to you. Firms calculate variation margin based on the day-to-day valuation changes directly observable on the market. Initial margin on the other hand, depends on the choice of model and reading price charts bar by bar its assumptions. Usually, the recipient of initial margin cannot reuse it for new investments.

Initial Margin vs Variation Margin

The variation margin calculation is done on a transaction-by-transaction basis as it depends on the type of security and its price movement. Therefore, a certain capital must be available in the account to initiate the trade. If the capital drops from the required level, the broker must add the difference to return it to acceptable levels. For investors or traders, variation margin is important as it informs them of the amount of funds that they need to solidify margin levels in order to trade. Collateralization is a widely adopted practice in the OTC derivatives market, with initial margin and variation as Fundamental forex trading the two main types of collateral.

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For centrally cleared trades, counterparties post VM to the clearing house; in non-cleared trades, to each other. Initial margin is the upfront capital required to open a position, while variation margin is an ongoing balance needed to maintain that position as market values change. Initial margin is paid upfront and serves as an extra layer of protection against delays in getting rid of collateral in the case of counterparty default. Additionally, initial margin should be segregated (meaning paid to a custodian, as opposed to directly between counterparties) and cannot be reused for investment purposes. You are exposed to the bank and are facing a potential loss if they default and fail to pay what they owe you.

The new initial margin amount required becomes $1,000 (50% of 100 shares x $20 per share). So the investor would have to add $500 to their account as a variation margin payment to meet the new initial margin requirement. As per the variation margin process, the clearinghouse collects this Rs 1,000 profit from Trader B (the losing counterparty) and credits it to Trader A’s account.