Initial Margin vs Variation Margin: Key Differences

Suppose Trader A enters into a futures contract for 100 shares of Company X at a price of Rs 200 per share. It helps prevent systemic risk by ensuring traders have sufficient resources to cover potential losses promptly, minimising the chances of defaults that could cascade across the financial system. On 16 August 2016 ISDA published the 2016 ISDA Variation Margin Protocol (the VM Protocol). The VM Protocol allows parties to amend their existing credit support documents, or to enter into new credit support documents, in a way which is compliant with the regulatory margin requirements. A market participant that wishes to use the VM Protocol adheres to the VM Protocol by sending a letter to ISDA, together with the applicable adherence fee.

If the market moves against the investor’s position, the variation margin may be required to protect against potential losses and maintain the proper margin ratio. Variation margin is the protective mechanism that ensures contracts are fully covered at all times, regardless of market fluctuations. It is calculated as the difference between the current market value of the derivative contract and the initial or previous margin requirement. It is used to ensure that a clearing member’s margin account is sufficient to cover the risk of the futures contracts held by the clearing member. The variation margin ultimately helps mitigate the risk for the parties involved in the contract and promotes stability in the financial markets. The amount of variation margin varies depending on the exact market conditions and price movement experienced over the course of the day.

  1. Variation margin is the protective mechanism that ensures contracts are fully covered at all times, regardless of market fluctuations.
  2. Margin requirements vary across different asset classes, as each type of asset carries its own inherent risk and potential for price movements.
  3. Final rules have been issued by both the “Prudential Regulators” for bank swap dealers and bank security-based swap dealers, and by the Commodity Futures Trading Commission (CFTC) for non-bank swap dealers.
  4. By upholding the requirements set forth in margin calls, the market can function efficiently, providing a platform for traders and investors to participate in a healthy and secure environment.
  5. Both parties need to keep the maintenance margin in their trading account, or the contract can be liquidated.

As this type of margin is calculated on a daily basis, it provides an immediate snapshot of the financial health of a portfolio. Should it fall, the brokerage will liquidate assets through a “margin velocity trade call”, should the account holder fail to supplement the portfolio up to the new margin requirements. In the Indian derivatives market, let’s consider a scenario involving variation margin.

It is because the buffer amount in the trader’s account has been reduced to a level that is unacceptable. A margin call is when a broker requires an investor to contribute additional funds to meet the required minimum margin amount. It is enacted when the account losses money, or additional positions are taken, causing the equity balance to fall below the required minimum for holding those positions. If the investor is not able to meet the margin call, the brokerage can then sell the securities in the account until the amount is met or risk is reduced to an acceptable level. There is an initial margin requirement, which represents the margin at the time of the purchase.

This process occurs on a daily basis, allowing for constant adjustments in response to the ever-changing market conditions. The process continues daily, adjusting the margin accounts based on these fluctuations. It ensures that both parties maintain adequate funds to cover potential losses. The ultimate aim is to reduce counterparty risk and ensure the fulfilment of financial obligations. Variation Margin represents funds that traders in derivatives or futures markets must add or deduct daily to cover profit or loss fluctuations. Tracked by clearinghouses, it settles differences between initial trade prices and market values, minimising default risk.

Examples of variable margin calculations

If their position decreases, the trader must pay the variation margin to the broker or clearing house. This daily exchange ensures that each party maintains the required level of collateral in their account. Moreover, brokers act as a liaison between traders and clearing houses, facilitating the efficient transfer of variation margin payments. They are responsible for monitoring the margin account balances, issuing margin calls, and ensuring that the clients fulfill their margin requirements in a timely manner. An investor buys 100 shares of stock at $50 per share with an initial margin of 50%. If the stock price falls to $25, the broker deducts $2,500 in losses from the initial margin balance, leaving it at $0.

The Securities and Exchange Commission (SEC) has proposed, but not yet finalized, margin rules for non-bank security-based swap dealers. The key deadline that people are currently working towards for variation margin is March 2017. So, the broker can call the buyer of the future and request to add the USD 25 to reach the threshold of USD 50. Comparatively, fixed costs are expenses that don’t change as the volume of goods and services produced does. One-time costs for things like machinery, for instance, are regarded as fixed costs because they remain the same regardless of how many products are sold.

How do initial margin and maintenance margin differ?

Other industry participants consider that the disadvantage of the Amend method is that it applies the regulatory margin requirements to transactions that do not need to be margined. As such, there may be a commercial or pricing implication of imposing new terms on existing transactions. ISDA has published various standard form documents (the ISDA 2016 Credit Support Annexes (VM)) that can be used to implement the regulatory variation margin requirements. Some jurisdictions have finalised their rules implementing the margin guidelines, so “Phase One” institutions have already put in place documentation to comply with those rules amongst themselves. Industry participants are now starting to prepare the documentation for their derivatives with other trading counterparties.

By requiring a deposit from the trader and maintaining liquidity through daily adjustments, the initial and variation margins help minimize the potential losses from unfavorable price changes. These margin requirements also discourage excessive leverage and prompt traders to close or reduce unfavorable positions. Initial margin refers to the percentage of the purchase price of a security that must be covered by cash or collateral when using a margin account for trading. It serves as a buffer to protect the brokerage firm, clearing house, and clearing member from potential losses due to changes in the price of securities in a trader’s account. In other words, initial margin requirement is a risk management tool that ensures the stability and orderliness of financial markets. Margin requirements vary across different asset classes, as each type of asset carries its own inherent risk and potential for price movements.

Used as Collateral

Clearing members are firms that are members of a clearinghouse, which is a financial institution that acts as a middleman in the derivatives market. Clearinghouses are responsible for ensuring that the variation margin is properly posted and for managing the collateral. Overall, variation margin gives specific protection to the traders and the clearinghouses as well. Since the clearinghouse/exchange acts as guarantor for the successful execution of the forward contract. Receiving funds under variation margin is a more excellent help for them, or they could go bankrupt as the default risk would have been much higher without any variation margin/collateral.

Risk glossary

We introduce people to the world of trading currencies, both fiat and crypto, through our non-drowsy educational content and tools. We’re also a community of traders that support each other on our daily trading journey. Variable contribution can be used to pinpoint production line bottlenecks and identify which of your products is the most lucrative and, consequently, worth continuing to produce. The greater the value of a security, the more margin interest is accrued to the lender. It is made even more attractive if the broker is a market maker with no need to resort to foreclosures and repossessions. Calculation of the variation margin involves straightforward arithmetic based on these marked-to-market changes.

Market participants are starting to prepare, distribute or receive documentation in connection with their (or their counterparties’) regulatory margin requirements. Initial margin and variation margin are both forms of collateral that are used in the derivatives market to reduce counterparty risk, but they serve different purposes. On the contrary, the variation margin is the amount required to top-up the trading account to the minimum margin level. The margin call is when the trader’s broker notifies that there is a need to deposit money in the trading account.

Once that consultation period is complete, the CSA would publish a National Instrument as the next step in the legislative process. The CSA Committee has indicated that it will be 2017 before the rules will be completed. It is only at that point that the rules would be adopted across provinces, based on the final form of the CSA proposals and on the basis of a phase–in timeline set out in the National Instrument. Final rules have been issued by both the “Prudential Regulators” for bank swap dealers and bank security-based swap dealers, and by the Commodity Futures Trading Commission (CFTC) for non-bank swap dealers. The delegated regulation is subject to an objection period by the European Parliament and the Council, after which it will be published in the Official Journal. The second phase, which applies to all other derivatives users (subject to certain exemptions), is scheduled to start in March 2017.

The investor’s equity would be only $1,500, or 30 percent of the value of the margin account. If the price of the stock declined further, the investor would hold less than 30 percent equity. At that point, the investor would receive a margin call from the brokerage firm. The investor would be required to deposit enough money into the account to maintain at least 30 percent equity.

Though some brokerages may require a larger deposit to satisfy initial margin requirements. Initial Margin is the amount required to open a position in a financial instrument. It acts as collateral to ensure that the trader can cover potential losses in case the market moves against their position.

A contract for difference (CFD) is a contract between two parties to exchange the difference in the value of an asset in the future. At the end of the trading day, due to market fluctuations, the price of Company X’s shares increases to Rs 210. This positive movement results in a gain for Trader A. The clearinghouse calculates the profit, amounting to Rs 1,000 (100 shares x Rs 10 increase in price). Protocols were developed by ISDA to enable market participants to put in place documentation on a standardised basis with multiple counterparties, reducing the need for bilateral negotiations. Institutions may also use more bespoke documentation or correspondence to help identify the appropriate margin requirements.


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