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Sorry if this is obvious, but I was reading up on Futures and the concept of variation margin intrigued me. Options settle like Stocks and have unrealized gain/loss without affect on cash flow during the position, but Futures have a system of variation where the price difference of the commodity/stock must be paid after each day, and they settle where the future buyer is paying market price, but the variation covers the difference. Why is it done this way? Is there a specific reason or did it just happen to be setup that way?

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  • $\begingroup$ My mistake! Do you know why it was setup this way but options aren’t? $\endgroup$
    – Ac905
    Jul 6 at 21:00
  • $\begingroup$ did the answer help? if it did answer your question, please select it. $\endgroup$
    – kdragger
    Jul 8 at 15:30
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Tricky right?

The reason is that when dealing with stocks or options or any sort of spot market asset, there is an original cash settlement. For instance: You have an account with $4000 and you buy AMZN for 3500. 3500 leaves your account and 1 share of AMZN comes in. Your account is now 500 + 1 share AMZN. AMZN price goes to 4000. Your account is now worth 4500.

Options work the same. You pay the premium (or receive) and then it gets marked to market. Prices moves and the pnl is change in account value based on the sum of all assets.

Futures are different. No cash changes hands. Settlement occurs as the future hitting your account and a "future" commitment to pay (receive) whatever you bought (sold). How do you figure out the equity of your account? Well, you need to know the prices transacted and then the changes over time.

Selling crude oil at 70 via the Nov 21 future does not put 70K into your account. Just a future. Futures go to $60. The only way to know your pnl is to know where you sold it and that is your equity -- in this case 10K.

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    $\begingroup$ Thanks! I think that makes more sense. It’s certainly strange at first that the buyer/seller need to pay variation for the current market difference. Is there a concern it can lead to problems with cash flow if a large whale wanted to manipulate the market? $\endgroup$
    – Ac905
    Jul 6 at 21:08
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    $\begingroup$ The exchange officials would argue that on the contrary it keeps the game honest, because if any big player on a particular day doesn't pay for his losses they can immediately investigate and pressure him to reduce his position. Solvency problems show up sooner. $\endgroup$
    – noob2
    Jul 6 at 21:15
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    $\begingroup$ Some exchanges do offer futures style options on futures where there is no upfront premium but daily variation margin between the option writer and buyer. What is nice with those is that American and European options have the same value in this setup so pricing is easier. Also exchange traded options demand daily variation margin from the option writer to mitigate credit risk. $\endgroup$
    – river_rat
    Jul 6 at 21:17

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