Futures margin mechanics | Finance & Capital Markets | Khan Academy

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Understanding the mechanics of margin for futures. Initial and maintenance margin.Created by Sal Khan.
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Finance and capital markets on Khan Academy: In many commodities markets, it is very helpful for buyers or sellers to lock-in future prices. This is what both forwards and futures allow for. This tutorial explains how they work and what the difference is between the two.
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[@michaeltr3602]

definitely better than a 2-hour lecture

[@chessislife3429]

So essentially the purpose of the immediate transfer through margin account is to make either the buyers or the sellers have no incentive to default the contract. At the point of the market price of future contract dropping, money is immediately taken from the buyer's margin account so that he will have no incentive to default.

[@tilarmeister]

Basically, mark to market for futures price (exchange call it the daily settlement price). the margin mechanics will use this settlement price to calculate and ensure daily profit and loss are accounted for in the buyers/sellers account. Example if the market price increase by $2: the seller would have an incentive to default as he will want to find new buyers in the market to sell it at a higher price. Therefore, this mechanic immediately deducts $2 and move it to the original buyer. this way, the seller would be indifferent as his "gain" from the $2 market movement is already gone, and will just continue with the contract. vice versa, if the market price decrease by $2: the buyer would have an incentive to default and try to find a cheaper contract on the market to buy from. by transferring $2 from the buyer's margin to the seller, the buyer would've clocked the loss. if they do default, at least the gain to the party benefiting from the price movement is already received.

[@clementecarbonaro619]

This guy walked me through SAT prep and is now explaining futures contracts to me. Amazing.

[@Orenji902]

You just explained a chapter of a text book with 4 colours and 3:38 minutes. Thanks!

[@Bigshot786100]

Thank you! finally i understood it. Couldn't understand otherwise even after watching 4 other videos on it.

[@briefcasefullofbanan]

HA I WAS SO CONFUSED BUT NOW I AM NOT CONFUSED

[@meetp6695]

Finally a clear concise explanation

[@gaelperrin3422]

If I could give this video two thumbs up believe me I would.

[@briefcasefullofbanan]

I watched it twice, just because i was so excited.

[@Mugwump720]

Okay, so it makes sense that a drop in the price will actually benefit the seller and hurt the buyer of a futures contract, but how does this contract protect the two parties from price changes? Could you do a side-by-side example of two parties entering this contract versus two parties subject to the market? Because I don't really see the difference.

[@fleshcookie]

Doesn't this defeat the whole purpose of the forward contract? Seems you are still in the hands of a changing market

[@RivieraByBuick]

+fleshcookie nope. you see, if the futures contract market price goes down, the seller is protected from getting less money by an income to his marging account, if the futures contract market price goes up, the buyer is protected from spending more money by an income to his marging account.

[@bhumikagupta6474]

+RivieraByBuick This explains.. Thanks!

[@OM-mu1qt]

Doesnt the margin account have money in it? Isnt he spending money by having to top up his margin account? Isnt he loosing money when money is taken from the account?

[@thomasnguyen2438]

@@OM-mu1qt I think thats the purpose of Future contract, to keep price stable and predictable. So if the price moves up one party has to paid and if it moves down the party has to paid, all of this to keep the price at a constant

[@thomasnguyen2438]

@@RivieraByBuick Thank you so much this cleared up everything!

[@pes1802]

Thanks for the great videos, they really help me a lot. I must admit though that I had some problems with this one. I really don't see what the whole margin system is good for. You are saying that, if the market price drops, the buyer will not want to keep his end of the contract, but after all he has entered into a legally binding contract, which obliges him to pay right? If, when the market price goes down, the contract changes, then what is the point of engaging in it in the first place?

[@xiaoyao596]

i was thinking of the same thing, doesn't really make much sense to me to do all this extra work, when forward contract does a much simpler job.

[@meetp6695]

In futures market transaction is done through stock exchanges. Here there is no way for the seller to trace the buyer. So in order to protect both parties from default MTM is done. So if in the above example prices stay at $190 and the buyer defaults, the seller can still his product at existing market price of $190 to a third party in the open spot market which would be in addition to the $10 he has already received in his MTM account. Sum of both comes to $200, i.e., same value as original contract and thus no loss to seller. Same will hold true vice versa also.

[@martynasmiliauskas4984]

I just watched the video myself and was a bit puzzled too. The key to understanding this is to see that even as the price drops $15 in two days, if the future's contract was to be settled at that point, both of the parties would exchange $200 worth of goods.

[@bigguschungus968]

Am I completely wrong here but why is he saying there is a margin call from the buyer who is in a better position? Would the margin called not be from the seller who is now 10 dollars short @190 for delivery therefore to meet the futures delivery price needs to cough up more VM

[@vuyiswapriscadlamini6207]

@@bigguschungus968 it is because if the price is lower, the buyer can opt to no longer buy at 200, that way the seller would lose their assurance of a future sale of 200, hence a future loss for the seller, the deduction from the buyer compensates the seller for the future, initially unwanted loss. Also once the Buyer starts losing money towards this contract, they might as well stick it through. This way, the profit/loss either can ever make would be the spot price, on the delivery date +/-200 and not like a 185

[@mehulsakariya6245]

That was so smooth!

[@garora10]

Just brilliant. Thank you so much !!

[@abeera6708]

VERY HELPFUL! Thank you

[@mba2ceo]

Best example I have seen !!!

[@TheCheryl2006]

excellent explanation

[@istilldontgetit]

Wow. THANKS!!!!

[@KL-ns8wh]

But what if the buyer cannot put more deposit into his margin account?

[@thebalance519-mindbodycryp4]

KHAN!!!!! You are brilliant. What an easy way to explain PNL for Futures. I just started crypto now and your 2011 video helped me!! THABNK YOU!!

[@CRISNCHIPS12398]

@N4RVS This is a channel dedicated to providing free education for the world on a wide variety of subjects.

[@manuelitopascal1925]

Amazing

[@RufioDeLaRocha]

@hossamrida he uses Smoothdraw

[@KavindaKottege]

In addition to that, it seems like the buyer is still paying $200 to the seller in each case.

[@ElRojasP]

Yes because these things happen with HUGE m/b/illion dollar trades, so the margin requirements protect investors from huge defaults on their contracts.

[@rohanmoorthy9658]

What about variation margin????? Unbelievable!

[@bongephiwazulu6373]

Well variation model is the additional amount an investor must provide to get back to the initial margin amount. I think variation margin= $15 because thr buyer had $5 which is below the maintenance margin of $10 so he has to pay the variation margin of $15 to get back at initial margin of $20

[@KavirRamdass]

What is the name of the program that you are using? it seems pretty handy a thing.

[@beastincarnate4221]

Hi, it has been 11 years you have commented on this video.

[@hossamrida]

@Kavir1618 he uses paint

[@sOetty]

Like it ... sO corlorful!!

[@taylor_o]

Those are some cheap apples... Guess there has been inflation, after all

[@vuyiswapriscadlamini6207]

kzbin.info/www/bejne/Z57RfHahosqUj9U this is the followup video on their website, it answers why the margin thing does not necessarily defeat the whole purpose