A futures contract is like a forward contract except there's an intermediary. The exchange who, you make your contract with the intermediary, not with the ultimate counter party, and they're standardized. If you drive through the country where they grow grains, you will see silos or warehouses here and there dotting the landscape. So, grain elevators are important. If you turn on the radio and listen to a local radio station, you will hear them quoting a futures market because farmers locally are very interested in those futures price. Some of them aren't protecting themselves, and so it's really big for them. Now you don't hear spot prices very often. Maybe you can tell me otherwise, but when I've been driving through the country I've been listening because spot prices don't mean anything. They're just a noise because you just never know who traded that. But the situation was the futures contracts are the things that the farmers listen to all the time. Now futures contracts rely on margin calls. >> When an investor uses margin to buy ourselves securities. They are paid for using a combination of his or her own funds as well as money borrowed from a broker. The investor receives a margin call from a broker if the securities in the portfolio decrease in value past a certain point. After which the investor must either deposit more money into the account, or sell some of the assets. >> So, I mentioned, with a forward contract. You're worried that the other guy might be a drunk, or might be irresponsible, might not plant the crop. Who knows? How do futures contracts deal with that? Well futures contracts, when you sign a contract, it's an active living thing. The contract requires you to pay a settlement every day from your futures margin account, based on the change in future is not going to add on that day. So the worker, have you signed a contract, you might not be very reliable person. You might be a person who sometimes goes for weeks without answering the phone. All right, they are taking care of that, in the contract. The contract says if you don't do anything, if we call you up and say your margin account is falling low because the future price is moving against you and you don't answer the phone we will close you out and your margin account will be, maybe, close to zero. We won't let it hit zero. Because they don't trust you, because they don't know who you are, they don't care who you are. They only look at the margin account. So you're supposed to allow them to deduct. They won't call you every day. If you are buying the futures and the price is going down, it is moving against you. You bought the futures because you were worried that the price would go up, right? And you want to lock in a price. If a price goes down, then it is moving against you, and so they will remove that amount from your margin account. You can get out anytime, but if you bought futures and price is going down, the reality is, you have to get out with the new price. So they've already taken the money from you. That was the deal from your margin account. And you don't have to answer the phone, you're not going to do anything. And it's no crime if your margin account is deleted. Of course, you won't be hedge it against price risk anymore. But you gotta answer the phone. That's why most people, most farmers don't trade in future, it's just too nerve wracking. Margin calls are very unpleasant. The guy tells you, well you put $10,000 in your margin account, I'm sorry to say it's down to $1,000. So they have what's called initial margin, is what they require you to put up. And they have something called a maintenance margin, which is when they make the phone call to you saying your account has gone against you. You either put up more margin or we will close you out, which means by offsetting. If you bought they would sell on your behalf. Then you're out of the market.
