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I would appreciate an explanation for the following problem:

Trader A is long a futures position worth $10 and Trader B is the short counterparty. Since it is exchange-traded the contract is cleared through a clearing house.

Suppose the value of the contract drops to $8 so Trader A is expected to make a Variation Margin payment at the end of day of $2 to the benefit of Trader B. However, Trader A closes out his position by going short the same contract before the end of the day. My question is, is trader A still liable for a VM payment? If not, who will pay trader B the VM amount? The new counterparty of Trader B (say Trader C) bought the contract at $8 so he would not be liable for a VM.

Thank you.

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The confusion here is that margins (actually all payments) all are settled with the exchange itself not between the counterparties. The exchange just makes sure the contracts balance so they don't have a the risk of a net position. Trader A has lost $2 and that must be settled out of their account with the exchange. The exchange will get those two dollars from A (in a few days) when the sale settles.

You are right though, the exchange posts money to B's account immediately so this seems dangerous for the exchange. This is why exchanges keep a initial margin along with this variation each day so they have have a pool of money to mitigate this cash flow risk and other risks.

  • Thank you for the reply, I am aware that the exchange will be the counterparty for both traders A&B. The point I am trying to make sure I understand is that trader A will not avoid paying the $2 even if he closes out his position before end of day, which is what you are implying correct? Closing out the position will just make sure he is not liable for any future payments. – PK89 Oct 18 '17 at 22:01
  • Yeah, Trader A will still have to pay the $2 but it will technically be "settlement" rather than "variation margin". Though the money may come out of the same account depending on the exchange. – rhaskett Oct 19 '17 at 0:11

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