This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
Variation margin is the daily mark-to-market payment that a leveraged position generates. At the close of each trading day, the broker revalues the position at the settlement price, and the difference between the previous close and the new close is the variation margin. If the position gained value, the variation margin is credited to the trader's account. If the position lost value, the variation margin is debited. The payment is a real cash flow, not an accounting adjustment.
Where variation margin comes from
Variation margin comes from the daily revaluation of the position. The position is marked to market at the close, and the mark determines whether the trader pays or receives. For a long position in a stock that closed higher, the trader receives variation margin equal to the price move multiplied by the share count. For a long position in a stock that closed lower, the trader pays variation margin equal to the price move multiplied by the share count.
The variation margin is calculated by the broker's clearing system, and the result is posted to the trader's account overnight. The trader sees the variation margin in the account balance the next morning, and the variation margin is included in the trader's cash balance for the purposes of margin calculation. A trader who has used the variation margin to fund another trade has, in effect, recycled the cash.
The difference between variation margin and initial margin
Initial margin is the deposit the trader posts to open a leveraged position. Variation margin is the daily mark-to-market payment that the position generates. The two are different in their function, in their timing, and in their effect on the trader's account.
Initial margin is posted once, at the opening of the position, and it is held by the broker as collateral. Variation margin is posted daily, and it is a transfer of cash between the trader and the broker (or, in the futures market, between the trader and the clearing house). The initial margin is the buffer that protects the broker against a default by the trader. The variation margin is the daily settlement of the mark-to-market value of the position.
A trader who has a leveraged position with a 50% initial margin and a 10% daily move against the trader will see a variation margin payment equal to 10% of the position size. On a €10,000 position, the variation margin is €1,000, and the trader's account balance falls by €1,000. The trader's equity is now €4,000 (the initial margin of €5,000 minus the variation margin of €1,000), which is 40% of the new position value of €9,000. The margin call fires at the maintenance margin, which is often 25% of the position value. The position is still above the maintenance margin, but the buffer is smaller.
Why variation margin matters in fast markets
Variation margin matters most in fast markets, where the daily moves are large. A trader with a leveraged position in a volatile stock can see a variation margin payment of 5% to 10% of the position value on a single day, and the payment is a real cash outflow. The trader who has not reserved cash for the variation margin is forced to close the position to meet the call, often at the worst possible moment.
The 24-hour period between the close and the next open is when the variation margin is calculated. The trader who holds the position over a weekend, a holiday, or a major event is exposed to the gap risk during the closed period, and the variation margin on the next open is larger than the typical daily move. The trader who is using leverage should size the position to the gap risk, not the daily risk, and the position should be sized to a small percentage of the account.
Variation margin in CFDs versus futures
Variation margin behaves the same in CFDs and futures, with one important difference. In the futures market, variation margin is paid through the clearing house, and the payment is guaranteed by the exchange. In the CFD market, variation margin is paid through the broker, and the payment is guaranteed by the broker. The CFD trader is exposed to the broker's credit risk, while the futures trader is exposed to the clearing house's credit risk.
The credit risk is small in both cases, because the variation margin is paid daily and the position is revalued every day. The risk is that the broker or the clearing house fails between the close and the next open, leaving the trader with an unhedged exposure to the gap. The risk is mitigated by the segregation of client funds and the capital requirements on the broker or the clearing house.
How to manage variation margin in your account
The honest answer is to size the position to the gap risk, and to hold cash in the account to meet the variation margin. The cash buffer is a function of the position size, the volatility of the underlying, and the trader's risk tolerance. A common rule is to hold cash equal to 20% to 50% of the position value, on top of the initial margin, to meet a 10% to 20% gap on the next open.
The trader who is using leverage for a long-term position is exposed to the variation margin over the entire hold period, and the cumulative variation margin can be substantial. A leveraged position that loses 2% per day for ten days loses 18% of its value in variation margin, even though the position is still open and the underlying is only 18% below the entry. The trader is paying 2% per day in real cash, and the cash is not available for other uses.
Related resources
Where to start
If you are using leverage, the most useful exercise is to calculate the variation margin on a hypothetical gap. Take your position size, multiply by 10%, and check whether you have that much cash in the account. If you do not, the position is too large for the buffer. Our broker comparison lists the margin policies and the variation margin procedure at each broker, which together tell you what the cash flow looks like before you open the position.