Variation margin

[ancl9]

It seems like there is a conflicting meaning of variation margin in the readings.

1. The institute for Financial markets (page 21 in GARP FRM book) seems to indicate that the daily settlement of gains and losses refers to variation margin (so not only in case of a margin call)
   
2. Hull Chapter 2: there is only a variation margin in case of a margin call

Am I misinterpreting one of the readings? Which meaning should we use in the exam?

Thank you,

 

[brian.field]

While I believe your second point to be mostly true, clearing house members post variation margin every day (they don't post in response to margin calls only) assuming that they have lost money during that day's market movement. (They also receive funds if they are "in the money" at the end of each day.)

 

[brian.field]

To be clear, see page 32 in Hull's text. "If in total the transactions have lost money, the member is required to provide variation margin to the exchange clearing house; if there had been a gain on the transactions, the member received variation margin from the clearing house." There is no need for a formal margin call in these scenarios.

 

[David Harper CFA FRM]

I agree with @brian.field and so I don't really think there is a difference between Hull and IFC. I would define variation margin as the difference between the margin balance and the required margin, either a shortfall or an excess. I think the perceived issue is between these two relationships:

1. Clearinghouse and clearinghouse member (or broker-dealer)
2. Clearinghouse member (or broker-dealer) and investor

Variation margin applies in both cases. But only the latter has a maintenance margin (if the maintenance margin is less than the initial margin, then daily losses are only reductions in the margin account balance until there is a margin call). In the case of clearinghouse and clearinghouse member (#1 above) variation margin is the gain or loss implied by daily settlement which is settled in cash

So: it is the maintenance margin which enables a margin call, which is a special case of collecting the variation margin. Clearinghouses (case #1) don't have maintenance margin such that variation margin is settled daily.

Whereas excess margin at the Clearinghouse (case #1) is automatically settled with the member, excess variation margin owed to the investor might not be automatically settled daily. Here is Hull on both:

Hull on The Clearing House and Its Members; i.e., #1 above

A clearing house acts as an intermediary in futures transactions. It guarantees the performance of the parties to each transaction. The clearing house has a number of members. Brokers who are not members themselves must channel their business through a member and post margin with the member. The main task of the clearing house is to keep track of all the transactions that take place during a day, so that it can calculate the net position of each of its members.

The clearing house member is required to provide initial margin (sometimes referred to as clearing margin) reflecting the total number of contracts that are being cleared. There is no maintenance margin applicable to the clearing house member. Each day the transactions being handled by the clearing house member are settled through the clearing house. If in total the transactions have lost money, the member is required to provide variation margin to the exchange clearing house; if there has been a gain on the transactions, the member receives variation margin from the clearing house.

In determining initial margin, the number of contracts outstanding is usually calculated on a net basis. This means that short positions the clearing house member is handling for clients are offset against long positions. Suppose, for example, that the clearing house member has two clients: one with a long position in 20 contracts, the other with a short position in 15 contracts. The initial margin would be calculated on the basis of 5 contracts. Clearing house members are required to contribute to a guaranty fund. This may be used by the clearing house in the event that a member fails to provide variation margin when required to do so, and there are losses when the member’s positions are closed out." -- Hull, John C (2014-02-19). Options, Futures, and Other Derivatives (9th Edition) (Page 32). Prentice Hall. Kindle Edition.

Hull on Investor and Broker; ; i.e., #2 above

"The investor is entitled to withdraw any balance in the margin account in excess of the initial margin. To ensure that the balance in the margin account never becomes negative a maintenance margin, which is somewhat lower than the initial margin, is set. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level by the end of the next day. The extra funds deposited are known as a variation margin. If the investor does not provide the variation margin, the broker closes out the position. In the case of the investor considered earlier, closing out the position would involve neutralizing the existing contract by selling 200 ounces of gold for delivery in December."-- Hull, John C (2014-02-19). Options, Futures, and Other Derivatives (9th Edition) (Page 30). Prentice Hall. Kindle Edition.

 

[[email protected]]

I am unable to understand how the gain/loss is calculated to be 180 when the price changes from 597$ to 596$ in the study notes.
As per my calculation the gain/loss for 6th june should be 200*(597-596)=200$ loss.
But your calculation shows as 180

Illustrated Example
In the following example (Hull, 2012), the investor is long two contracts, the initial margin is
$4,000 ($2,000 per contract) and the maintenance margin is $3,000 ($1,500 per contract).
Note the margin call is triggered when the margin account balance breaches the
maintenance margin; however, the investor must “top off” the account back to the initial
margin, not just to the maintenance margin.
Contract Specifications:
Contract Size (ounces) 100
# Contracts 2
Ounces: 200
Initial Futures $600
Margin Per Total
Initial margin $2,000 $4,000
Maintenance margin $1,500 $3,000

 

[David Harper CFA FRM]

Hi @[email protected] Our apologies, you are quite correct. The futures prices in that exhibit fail to show the two decimal places; i.e., the June 6th price is supposed to be $596.10 rather than the displayed $596 (please see below). We currently have a new version of this Hull document in review (to be published soon) that is much improved and contains this correction. Thanks!

 

[[email protected]]

thank you!!