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Let’s verify that the margin mechanics
and 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 20 cents a pound,
or buy the apples for 20 cents a pound.
And they didn't want to,
in the farmers case, go out of business
if they could only sell the apples for 10 cents a pound –
or in the pie company’s case, go out of business
if they have to buy the apples for 30 cents a pound.
So let’s verify that this works out.
So they originally had a contract price
of $200 dollars for 1000 pounds.
So this is essentially 20 cents a pound.
20 cents 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 price of –
As the delivery price in the futures contract goes down,
in order to mark the delivery prices down –
so, in order to mark it down
from $200 to $190 dollars to $185 dollars –
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 15th –
(Remember this is the delivery date.)
– the future's 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.
Let's say that this goes all the way down to $100 dollars.
So in that whole process, this futures contract
keeps getting marked down to $100 dollars.
So on that day, it is true
that the seller will sell $1000 pounds of apples
to the buyer for only $100.
You might say, “Hey wait. What'd the seller get out of this?
He’s only getting 10 cents 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 dollars to $100 dollars,
there would have been a transfer –
from this guy's margin account
to this guy's margin account –
of 100 dollars.
So instead of just getting the $100 dollars
for that thousand 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 dollars –
no matter what –
for his 1000 pounds of apples –
or 20 cents 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?
– $300 per 1000 pounds?
Well, you might say, “Hey!
The seller’s going to get a bonanza.
And this guy's going to go out of business –
because he's going to be
essentially paying 30 cents a pound!”
But you’ve got to remember.
If the price goes up, and it becomes
more and more favorable to the seller –
because of the margin mechanics,
the seller would have to transfer $100
as the price moves up –
to the buyer –
to his margin account.
And so, even though this guy
has to pay $300 dollars per [1000 pounds] –
because that's where the market price
eventually ended up –
he would get $100 dollars from the seller.
So, effectively, he would still only have to pay $200 dollars.
And even though this guy’s selling it for $300,
he actually had to pay another $100 dollars.
So net, he's really only getting $200 for it.
So no matter how you look at it,
both parties are transacting at $200 dollars,
or 20 cents a pound.