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Outline how a margining process is put into practice and compute initial and variation margin requirements.

FRM® Part I · Financial Markets and Products · Exchanges and OTC Markets · FRM1.FM.5.d

The idea

Exchange margining has three parts. Initial margin is the deposit the clearing house requires when a position is opened, sized to cover a plausible adverse move. Variation margin is the daily settlement. The account is marked to market at the settlement price, and the day's gain or loss is added or removed. Maintenance margin is a lower level. The balance may drift below the initial level without a call. Once it falls below maintenance, a margin call requires a deposit that restores the balance to the initial margin, not merely to the maintenance level. For futures, the daily gain or loss on a position is: Gain = price change × contract size × number of contracts. The sign is set by whether the position is long or short. Balances above initial margin can be withdrawn. Calls are met in cash or in eligible securities valued after a haircut.

Formulas

Daily gain or loss on a futures position

daily gain = ΔF × contract size × N

ΔF
the change in the settlement price since the previous settlement
contract size
the units of the underlying in one contract
N
the number of contracts

Positive for a long when the price rises, negative for a short. If the balance falls below maintenance margin the call restores it to the initial margin, not to maintenance.

A practice question

From the question bank, with the reason each wrong option is wrong.

In futures clearing, what is variation margin?

  1. The deposit a trader must post when first opening a positionWhy not: This describes initial margin, not the daily settlement.
  2. The minimum balance below which a margin call is triggeredWhy not: This describes maintenance margin.
  3. A per-contract fee charged by the clearing houseWhy not: This describes a clearing fee, which is a cost and not a margin deposit.
  4. The daily payment that marks the position's gain or loss to market - correct

Variation margin moves daily gains and losses between accounts at the settlement price. Initial margin is the opening deposit and maintenance margin is the call trigger.

A harder one

A trader buys 20 crude oil futures (1,000 barrels each) at 80.00. Initial margin is USD 6,500 per contract and maintenance margin is USD 5,000 per contract. The account holds exactly the initial margin. The first settlement is 78.20. What deposit is needed?

  1. USD 6,000Why not: Restores the balance only to the maintenance level of 100,000 instead of the initial level.
  2. USD 36,000 - correct
  3. USD 130,000Why not: Re-posts the entire initial margin instead of the amount lost.
  4. USD 1,800Why not: Uses the loss per contract and ignores the 1,000-barrel multiplier and 20 contracts.

Loss = 1.80 x 1,000 x 20 = 36,000. Balance 130,000 - 36,000 = 94,000, below maintenance 100,000, so a call restores it to 130,000, a deposit of 36,000.

The hardest tier

A trader buys 10 stock index futures (multiplier 250) at 4,500. Initial margin is USD 20,000 and maintenance margin USD 18,000 per contract. The account starts at exactly the initial margin. The first settlement is 4,494 and the second is 4,490. What deposit is required after the second day?

  1. USD 5,000Why not: Restores only to the maintenance level of 180,000 rather than the initial level.
  2. USD 10,000Why not: Covers only the second day's loss, ignoring the loss carried from the first day.
  3. USD 15,000Why not: Covers only the first day's loss, which never triggered a call.
  4. USD 25,000 - correct

Day 1 loss = 6 x 250 x 10 = 15,000, so the balance is 185,000, above maintenance 180,000: no call. Day 2 loss = 4 x 250 x 10 = 10,000, so the balance is 175,000, below maintenance. The call restores 200,000: 25,000.

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