Variation Margin - Are You Overlooking It?

One often-overlooked risk in hedging is 𝘃𝗮𝗿𝗶𝗮𝘁𝗶𝗼𝗻 𝗺𝗮𝗿𝗴𝗶𝗻 (𝗩𝗠)—and it can be a serious cash drain if not planned for properly. Right now, this is especially relevant as many traders hold 𝗖𝗠𝗘 𝗰𝗼𝗽𝗽𝗲𝗿 𝗽𝗼𝘀𝗶𝘁𝗶𝗼𝗻𝘀 tied to their physical trades.

🔍 𝗛𝗲𝗿𝗲’𝘀 𝗮 𝗿𝗲𝗮𝗹-𝘄𝗼𝗿𝗹𝗱 𝗲𝘅𝗮𝗺𝗽𝗹𝗲:

A trader books a CME/LME arbitrage at $700/mt CME over LME by selling CME copper futures and buying LME copper futures. This effectively converts their LME physical purchase into a CME physical purchase, leaving their only open futures position as a CME short.

But what happens if 𝗖𝗠𝗘 𝗰𝗼𝗽𝗽𝗲𝗿 𝗿𝗶𝘀𝗲𝘀 𝗯𝘆 $𝟭,𝟬𝟬𝟬/𝗺𝘁?

✅ From a hedging perspective, they’re still covered.
💰 But now, they must finance the VM on this trade.

𝗛𝗼𝘄 𝗠𝘂𝗰𝗵 𝗖𝗼𝘂𝗹𝗱 𝗧𝗵𝗶𝘀 𝗖𝗼𝘀𝘁?
Let’s assume a 2,000MT position (realistic, considering the 500,000MT copper heading to the US):

$1,000/mt price increase x 2,000MT = $2M in VM

VM is typically cash-financed once a credit-line is breached, not part of a borrowing base or repo.

Cash financing cost: ~$450/day = $27,000 over two months

For a 5,000MT or 10,000MT position? That’s $10M+ of daily cash liquidity required. 🚨

𝗧𝗵𝗲 𝗥𝗶𝘀𝗸 𝗠𝗼𝘀𝘁 𝗧𝗿𝗮𝗱𝗲𝗿𝘀 𝗢𝘃𝗲𝗿𝗹𝗼𝗼𝗸
In the case of the current arbitrage trade, where most traders hope to make 100s of dollars a ton profit, an additional cost of $13.5/mt probably isn't a deal breaker. However, many traders only realize the impact of VM after the trade is booked—when finance/accounting finalizes the deal. In more normal trading:
💡 What was supposed to be an $80/mt profit might only be $65/mt—a nearly 20% reduction in gross profit.

👉 𝗔𝗿𝗲 𝘆𝗼𝘂 𝗳𝗮𝗰𝘁𝗼𝗿𝗶𝗻𝗴 𝗶𝗻 𝗩𝗠 𝘄𝗵𝗲𝗻 𝗮𝘀𝘀𝗲𝘀𝘀𝗶𝗻𝗴 𝗱𝗲𝗮𝗹𝘀?