In Q&A Bank 1, Q1.12, there is an investor who enters into a long futures position. My understanding is that if the investor loses money through daily market price movements, they have to deposit a variation margin to their margin account to offset the increased credit risk to the clearing house. However the solution suggests that when he makes a loss, his margin account actually reduces. In fact, in part i) it states the holder of a long futures position will be required to deposit additional variation margin. Am I getting confused?
Hi, You are right that, when an investor loses money he may have to deposit more margin in the account. However that only occurs if the account falls quite a lot - to below a "maintenance" level. Only then will variation margin have to be deposited. The Q&A example shows the margin account going up and down with profits and losses, but because it never reaches the maintenance level, variation margin is not required. The confusion probably arises because of the description above the table. This suggests that variation margin will always be required on a daily basis when the price drops. That probably lead you to believe that each time a loss was made, the margin account would be topped up. Hope this helps.
You are right - if the investor loses money they will have to deposit additional margin. In practice, to avoid moving money around daily (possibly for small amounts), the investor will have funded a margin account with his broker which will reduce (/increase) with his daily losses (/gains). He needs only to top this account back up with variation margin to the initial margin level if it falls below a specified level – called the maintenance margin.
Ah yes, that makes more sense. I guess I should regard it in the same way as a stockbroker would run the margin account with their clients, using "maintenance levels". Many thanks for your help.
