Template:Variationmargindescription

Variation margin is a credit mitigation technique designed to minimise credit risk under derivative transactions. It requires derivative counterparties give each other collateral — typically cash — each day to ensure that their net collateralised exposure is (more or less) nil. For example, if the net replacement value of the swaps between two counterparties on a given day is $10 million, the “out-of-the-money” party, who would have to pay it were all the transactions terminated, has to pay the “in-the-money” counterparty $10 million in cash (subject to agreed thresholds and minimum transfer amounts). This happens every day; variation margin can be paid either way, depending on how the net portfolio moves. Volatile markets can quickly move — a day is a long time when black swans are on the wing — so parties often want a little something extra to tide them over for expected movements between now and the next variation margin payment date. For that, you need initial margin.