Variation margin

Variation margin is the cash amount by which the clearing house decreases or increases the account of a derivatives position holder after each clearing session. A profit on a futures contract does not wait for the trade to be closed: it arrives in the account as cash straight away, and a loss leaves the account just as immediately.

How variation margin is calculated

At each clearing session the exchange fixes the settlement price of the contract. Variation margin equals the difference between the new settlement price and the previous one, converted into roubles through the tick value and multiplied by the number of contracts. If the position was opened during the day, the trade price is used instead of the previous settlement price. After the calculation the position is, in effect, reopened at the new settlement price, and the next revaluation starts from there.

The derivatives market is a zero-sum game: whatever is debited from one side is credited to the other. The buyer receives money when the quoted price of the contract rises, the seller when it falls. The main settlement for the day takes place at the stage known as the evening clearing, while the intraday clearing adds an interim revaluation.

How variation margin differs from collateral

Variation margin is often confused with the amount the exchange blocks against a position — that is the initial margin. Collateral is merely frozen and will be returned when the position is closed, whereas variation margin is a real movement of money. The link between the two is direct: debited variation margin reduces free funds, and if they fall below the required collateral, the broker sends a margin call or forcibly closes part of the position.

Example

The table below shows the day's most actively traded futures:

For each of these contracts, the price change since the previous clearing turns into variation margin for all holders at once: buyers receive money when the price rises and pay it out when it falls, sellers the other way round. The more actively the price moves between clearing sessions, the larger the sums that pass from one account to another.

Where the term causes confusion

The word "margin" here has nothing to do with business profitability: gross margin describes the share of revenue a company keeps, whereas variation margin is a cash flow on an open position. All they share is the root of the word.

The second mix-up is treating a positive daily variation margin as the result of the trade. It is only the stretch between two clearing sessions; the financial result is the sum of all such stretches from opening to closing.

The third is applying the mechanism to any option. Variation margin accrues when the option is margined: a margined option is revalued at every clearing session, like a futures contract. With a premium-style option the buyer pays the premium up front, and there is no daily movement of money on it.