Let's verify that
the margin mechanics in the marking to market
of the futures contract actually gets both the seller
and the buyer what they originally wanted, which
is that they don't have to be susceptible to the
volatility in apple prices. They both wanted
to, effectively, sell the apples for $0.20
a pound or buy the apples for $0.20 a pound. And they didn't want to,
in the farmer's case, go out of business if they could
only sell the apples for $0.10 a pound, or in the
pie company's case, go out of business if they had
to buy the apples for $0.30 a pound. So let's verify
that this works out. So they originally
had a contract price of $200 for 1,000 pounds. So this is essentially
$0.20 a pound. And as we said in
the previous video, as the futures contract
delivery price changes day by day, as we get closer and
closer to the actual delivery date, what happens
is that we transfer money between the buyer's margin
account and the seller's margin account. As the delivery price
of the future contract goes down, in order to mark
the delivery price down-- so in order to mark it down
from $200 to $190 to $185-- this guy keeps getting a better
deal on the actual delivery price. So to make things fair, he has
to transfer the same amount of money to the margin
account of the seller. So let's imagine two scenarios. Let's say that
eventually, as we approach November 15-- remember,
this is the delivery date-- the futures contract
delivery price is going to approach
the market price. You can imagine right
when we're like a second before the delivery date, the
futures contract and the market price aren't going
to be that different. And let's say that this goes
all the way down to $100. So in that whole process,
this futures contract keeps getting
marked down to $100. So on that day, it is
true that the seller will sell 1,000 pounds of apples
to the buyer for only $100. You might say, hey, wait. What did the seller
get out of this? He's only getting $0.10
per pound for his apples. This was what he feared. He is susceptible to the
volatility of the market prices. But remember, because of this
marking to market, and because of the margin transfers here,
as this delivery price went down from $200 to $100,
there would have been a transfer from
this guy's margin account to this guy's margin
account of $100. So instead of just
getting the $100 for that 1,000 pounds of
apples, because this seller had this futures contract,
he would have also gotten another $100 transferred
into his margin account. So the true economic value he
gets is $200, no matter what, for his 1,000 pounds of
apples, or $0.20 a pound. You can imagine
the other scenario. What if the delivery price
as we get closer and closer to delivery date goes up? If it goes to $300
per 1,000 pounds? Well, you might say, hey,
the seller is going to get a bonanza, and this guy's
going to go out of business because he's going to be
essentially paying $0.30 per pound. But you gotta remember,
if the price went up and it becomes more and more
favorable to the seller, because of the margin
mechanics, the seller would have to transfer $100 over--
as the price moves up-- to the buyer, to
his margin account. And so even though this guy
has to pay $300 per pound, because that's where the market
price eventually ended up, he would get $100
from the seller. So effectively, he would
still only have to pay $200. And even though this guy
is selling it for $300, he actually had to
pay another $100. So net, he's really only
getting $200 for it. So no matter how you look at
it, both parties are transacting at $200, or $0.20 a pound.