The clearing house will calculate the VM and initial margin (deposit)
for the transactions, resulting in open positions and closed-out
positions.
Variation margin
Variation margin is the revaluation by a mark to market (MTM)
process of positions. The resultant value is for settlement with the
clearing house.
Example
An investor purchases 1 March Long Gilt futures contract on
Euronext.liffe at a price of 102.05. From the contract specification
we see that the tick size and value is 0.01 and £10 respectively.
That evening the contract’s closing market price on the exchange
is 102.10.
It has moved 5 ticks (102.10 102.05), so the VM will be:
Number of contracts number of ticks tick value 5 5 £5
£125
The investor has purchased (gone long) the contracts and the price
has risen, so the VM represents the profit the investor has made. It
will be paid to the investor. Had the price gone down, the investor
would have had to pay the broker. The VM will be settled the next
day, T 1, between the broker and the investor and between the
clearing house and the clearing broker. Every day the position is
open, this revaluation, or mark to market, process will occur and the
resultant VM will be due for settlement.
Initial margin
Open positions in futures contracts are subject to a margin call
that is a returnable deposit payable to the clearing house by the
clearing member and by a client to their broker. The margin is
referred to as either a deposit or more often the initial margin. The
rate at which the margin call is made is determined by the
exchange clearing house and, as it is a risk management tool
employed by the clearing house, it can be changed if volatility in the
market changes.
Futures processing 55
Initial margin requirements can be covered by either cash or, in
most cases, collateral that is acceptable to the clearing house or
broker.
Initial margin and collateral are dealt with in more detail in
Chapter 8 but let us look at an example of the VM and initial margin
settlement flow for some FTSE 100 Index Futures trades.
Example
Day One
Trade 1: Purchase of 250 June FTSE 100 Index Futures @ 4344
Closing Market Price: 4350
Day Two
Trade 2: Purchase of 250 June FTSE 100 Index Futures @ 4360
Closing Market Price: 4365
Day Three
Trade 3: Sale of 300 June FTSE 100 Index Futures @ 4362.5
Closing Market Price: 4357.5
Assume that the initial margin rate is £500 per contract and the
sale on Day Three is a closing sale.
Tick size and value 0.5 and £5 respectively.
What is the settlement flow?
Date Trade Long/ Short/ Price Closing Variation Initial
B/Fwd Buy Sale price margin margin
C/Fwd
xx/xx/xxxx Trade 250 4344.0 4350.0 15 000 125 000
yy/xx/xxxx B/fwd 250 4350.0 4365.0 37 500 125 000
Trade 250 4360.0 4365.0 12 500 125 000
zz/xx/xxxx B/fwd 500 4365.0 250 000
300 4362.5 4365.0 7500
C/fwd 200 4365.0 4357.5 15 000
aa/xx/xxxx B/fwd 200 4357.5 100 000
56 Clearing and settlement of derivatives
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