What is a Variation Margin?

Sometimes referred to as a market to market margin, the variation margin involves additional deposits of assets when market fluctuations demonstrate a higher degree of volatility. Variation margins are submitted to the clearinghouse handled the transactions by the clearing member. The payment of a variation margin may occur on a daily basis or a less frequent but consistent schedule, based on the degree of volatility connected with the investment.

Generally, a variation margin is not required when the underlying assets associated with a given option are considered to be stable. However, if there is a perception that some type of adverse movement regarding the asset is about to take place, the clearinghouse handling the option transactions may require some additional security or collateral in order to write the order. A cash flow from the clearing member to the clearinghouse will be maintained in an account set up for the clearing member and only utilized if the perceived adverse conditions prove to be real and appear to be enduring in nature.

Tracking the market value of a given option is essential to determining whether or not a variation margin is necessary. Often, the clearinghouse will base the determination on the change in performance from one trading period to the next, or one calendar day to the next. A variation margin is not likely to be invoked if the stock drops a few points for a couple of days. However, if the stock continues to drop over several days, the clearinghouse may ask for a variation margin.

Along with watching actual stock performance, the clearinghouse will also monitor for any news of adverse conditions going on with the issuing company. For example, word that a hostile takeover is about to take place will likely depress the value of the stock until the matter is resolved. Upon learning that a takeover attempt is in progress, the clearinghouse may require a variation margin until the takeover either is defeated or takes place. At that point, the action will be reviewed and a determination made if the margin is still required, or it variation may be lifted.