Variation Margin
19 hours agoA variation margin is a type of margin payment utilized in financial markets, particularly in the trading of futures, options, and other derivatives, to account for the fluctuations in the value of an open position due to daily price changes.
The primary aim of the variation margin is to ensure that the trading parties maintain adequate collateral in their margin accounts to cover potential losses and avert default on their obligations.
In derivatives trading, such as futures and options contracts, the value of a position fluctuates daily as a result of market price movements.
The variation margin is determined at the end of each trading day based on the settlement price, which is the official closing price of the contract.
If the value of the position has risen, the party holding the profitable position receives a variation margin payment from the counterparty who has incurred a loss.
This payment process is referred to as “marking to market,” as it ensures that the position's value is updated daily to reflect the current market price.
The variation margin plays a crucial role in managing the credit risk associated with derivatives trading by ensuring that the involved parties maintain sufficient capital to cover potential losses.
Additionally, it facilitates the regular transfer of profits and losses between the parties, thereby reducing the risk of default on the contract’s obligations.
It is essential to understand that variation margin differs from the initial margin, which is the upfront collateral required when establishing a derivatives position.
While the initial margin acts as a security deposit to cover potential future losses, the variation margin represents the daily changes in the value of the open position.
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