Question 1

I don't really understand what the benefit of the margin account is for the buyer when the futures contract delivery price goes down. Without the margins account he would have to buy the apples for $200, and with the margins account he has to buy them for $190 + give $10 of his margins account to the margins account of the seller! What am I not understanding? Basically I'm trying to ask, what's the use of the margin accounts if the outcome is the same anyway? Just so that the buyer does not feel "stupid" at paying a price higher than the market price? But surely the buyer understands that he does, essentially, still pay a higher price than the market price when taking the transfers in his margin account into the equation?

Accepted Answer

The margin is not meant to benefit the parties. Its purpose is to give the exchange a degree of security. The margin essentially means that one party will have to give part of the value promised in advance of the date agreed. This makes it less likely that that party will breach the contract, making it less likely that the exchange will have to pay out under the guarantee it offers. Furthermore, even if one party does default on the contract, the exchange will have less to pay out as guarantee, since part of the value promised will already have been transferred via the margin mechanism.

Question 2

Hi, I have a question. At the very end of the video, you said that the buyer has to add $15 to return his maintenance margin to the original value of the initial margin. Why would he do this? Wouldn't the buyer eventually realize that all the supposed 'savings' he was receiving from the drop in the price of the future contract was actually coming from his own pocket? Thanks in advance!

Accepted Answer

2 things can happen: (1.) The buyer can realize he is in a contract for a reason and add the $15 to his account, which really won't lose him any money because in the end he will still have forked over $200 for something he agreed to buy.

and (2.) He can refuse to add $15 more dollars, and he will lose the $15 (or probably the entire $20) he already set aside as margin and be free to go out and buy a contract on the market.  Currently, the price is $185 so he would be getting break-even (or possibly losing $5 if he forfeited the money left in his margin account).  If he thinks the market will keep going down, then he can wait for that to happen and buy it when it gets lower.  Then he made a smart move.  But the market could always go back up!  What if it goes back to $200 the next day?!  Then he wasted a lot of money.  This gives him incentive to just fork over the $15 now rather than go back to the volitile market.

And what happens to the seller in this case?  Well its simple, he gets to keep the $15 margin that was added to his account and go out and get a new contract where someone will pay him $185.  So he breaks even and really its like nothing changed from his original $200 contract.

Question 3

wait do you get to keep the margin call that you put up if you do sounds like good deal and your bound to make a profit but if you don't then your pretty much paying higher price.

Accepted Answer

Yes, you keep the margin that you initially put up. If apples closed at $200 per 1000 lbs., both parties would go home with their $20.

Question 4

I have the exact same question.  Margins seem to reintroduce the volatility the forward contract was said to reduce.  Can anyone explain how margins reduce volatility for the buyer or seller?

Accepted Answer

First of all, we're talking about futures contracts, not forwards. Futures contracts reduce volatility by eliminating price risk - the risk that the market price will change from what you're willing to pay. Margins reduce volatility by eliminating counter-party risk - the risk that the exchange will end up buying the product because the original buyer disappears without having paid anything.

Question 5

So the margin is basically a down payment that adjusts over time?

Accepted Answer

Not really; a downpayment is typically for buyers only. Margins are for buyers and sellers. Also, your analogy to a floating downpayment would probably adjust in the same direction as the price, which is not necessarily the case for margins.

Margins are collateral required to enter into a transaction. They are determined in function to the riskyness of the commitment to ensure they will be acted upon.

Margins are adjusted when prices move to compensate for the subsequent advantage or disadvantage resulting from the transaction. If the price movement is in your favor, there is a lower risk you will reneg on your commitment and the margin requirement may be lowered. If the price moves against you, there is a higher risk you would reneg, hence you are called for further margin to keep the position open. If you can't follow, your position is closed using your margin deposit if needed.

Question 6

does the Future's Contract itself indicate whether it is for the Buyer of the Commodity or the Seller of the Commodity?
I mean, for all I know, the Future's Contract only holds information on the settlement price, the commodity detail, and the date of settlement.
How does the Exchange find out if the person holding the Future's Contract is the Seller of the Apple, or the buyer of the Apple?
Sal should explain these things.

Accepted Answer

A contract is either a contract to buy or a contract to sell.
If you want to be able to buy the commodity at some set price in the future, you purchase a contract to buy.
If you want to be able to sell the commodity at some set price in the future, you purchase a contract to sell.

Question 7

And along the same lines as the previous questions,  what if buyer doesn't have $150 do add to his margins?  Does he default on the contract?

Accepted Answer

hi,
You could say that he defaults on the contract. If the buyer refuses to add the extra $15 dollar. The contract is unbound. So the seller can sell his contract to someone else. The loss of the buyer is 20$. In a 'good' contract those 20$ aren't lossed by the buying or selling party. The margin is just there as an assurance to both parties that they will keep their end of the deal (or lose 20$)

Finance and capital markets

Unit 9: Lesson 2

Futures margin mechanics

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