Let's think a
little bit about how margin works for a
futures contract. So let's say that the
terms of the contract are a 1,000 pounds of apples
for delivery on November 15, and we're assuming that this
is some date in the future. And right now in the
Futures Exchange, the market delivery
price, so the price at which the apples will change
hand in the future, is $200. And I've written here what
the exchange specifies for the initial and
maintenance margin, we'll talk about that
more in a second. But this essentially means that
both the buyer and the seller, for the initial margin,
have to put up $20. Sometimes it'll be specified
as an absolute dollar amount like I've just done. Sometimes it might
be a percentage of the actual delivery price. So they both have to
put up $20, and this guy has agreed to buy a
1,000 pounds of apples from this guy on
November 15 for $200. So it's essentially
$0.20 a pound. Now, let's say
that a day goes by, and the next day-- these
guys have this contract. This price right here
is fixed in their minds. But let's say, the next
day, the same contract between two other parties
trades with the delivery price of $190. Now, all of a sudden this
guy over here feels silly. He's like, man, I'm
agreeing to buy something for $200 in the future
which some other dude, all of a sudden, has
agreed to buy for $190. This guy over here
feels really smart. He agreed to sell something
for $200 the day before, and now people are
selling it for $190. So he's kind of $10
better than the people participating in the
Futures Market today. The way market to market
works with futures contracts is that the exchange
says, well, you know what? I'm afraid that this guy, if
things keep moving against him, he's not going to even
want to put up the money to buy it at $200 if he can
buy in the market at $190 or something lower. So I'm going to reset their
futures contract to a delivery price of $190, but,
to make things fair, this guy's going to
be $10 in the hole. He's getting a $10 deal. If I take the delivery
price from $200 to $190, I need to take
$10 from this guy, because he's getting
a $10 better deal. So from his margin account,
I take it from $20 to $10. And then I place the $10 in
this guy's margin account. If he's going to get
$10 less of a good price on the delivery date, than let
me give him the $10 right now. So his margin account
will go to $30. Now, this number was
18, 17, 16, or 15, this guy wouldn't
have to do anything. But right here, he's triggered
his maintenance margin. Actually, he's right at
our maintenance margin. So let's say that he goes--
that the next day, this happens a little bit more. It goes down to $185, and we
have to do the process again. This guy loses $5,
he goes down to $5, This guy will be given
$5, so he goes to $35. In order for him to essentially
reset the Futures Price, he's been given another $5. Now, this guy has only
$5 in his margin account, and the maintenance
margin is $10. So triggers a margin
call, and this guy's got to find some place to put
another $15 in his margin call. Every time you get below
the maintenance margin, it triggers a
margin call, and you have to refill your margin
account to the initial margin. So he has to add $15,
so he gets back to $20.