Margin Call Movie Explained

hey YouTube it's Dimitri and today we're gonna talk about a movie because one of our subscribers here aldor asked me to hear you thanks for sharing your life story I wanted to ask one question can you make a video about the movie called margin call and explain what happen there from a quantitative finance standpoint okay so this is more traditional finance it's just how markets work we'll talk about it big disclaimer though I have not seen the movie but I have looked up the plot and read all about it so let's just dive on in and talk about this okay so there's two components playing into this movie plot line here so basically what happens is somebody took a really really big position and in the movie right the world is gonna end it's gonna bankrupt the entire firm and they need to get out of that position quickly that's the general plot here but the reasoning under why the position is so dangerous I think is something that is more or less the question here first off let's talk about margin real quick so the movies called margin call when you have a position in your in a trade for example so example in options you'll have essentially two people that are in opposite positions of a bet here so somebody says you know if the market goes up I don't pay you let's say dollar for dollar as it goes up and then somebody else in another position saying you know if the market goes down you pay me dollar for dollar so let's just say you have $100 and the one person if it goes up to like 105 dollars this person right they get five dollars from this person so they agreed to give them five dollars then in the opposite store - so let's say you're out $100 it goes down to I don't know let's say ninety two dollars so it's dropped eight dollars now this person that was taking the long position so betting it's gonna go up they're gonna pay the short position which is they will give eight dollars to this guy and he'll benefit when it goes down so there's this contract right but typically there's a time frame on the contract so what ends up happening is you enter in the contract let's just say January first and let's say by the end of January so January 31st that's when we're gonna settle up on the final contract we'll see who essentially is the winner and the loser and then the contract ends the issue though is that over the month the stock price is going to bounce around so let's say it's a hundred dollars and it drops to like I don't know 70 dollars all of a sudden because it's high volatility and then it goes back up to 105 right depending where you are in the month you don't really know who's gonna win and lose until the final date when the contract closes and then whoever's up or down pays the other person based on the position but one of the risks with this is that lets say the stocks at $100 and it drops to say $70 so there's a thirty dollar gap here and one party's gonna have to pay the other party thirty dollars what if they don't have the thirty dollars to pay you so for some reason they're not financially stable and they're unable to make that payment this is called counterparty risk so your counterparty is unable to cover that position right it seems crazy when you say a hundred dollars and thirty dollars but typically these positions can be you know ten thousand dollars they can be a hundred thousand dollars they could be a million dollars so again having you know that right a million dollars to pay over to their party you might not just have it and so what ends up happening is to reduce this counterparty risk over the time frame of the contract so in this case over January there's limits set so say this stock or the asset here is started at $100 all right and there's margin bands put in place here I guess those other terms for these but this is me just hodgepodge doing this together what ends up happening is when the stocks bouncing around nobody changes money but then when you cross one of these bounds so let's say there's a ten dollar up and a ten dollar down here if the stock price gets to 110 then they have what's called a margin call so you have to put margin up front as well so just like money it essentially states that you're able to cover the position when you hit a margin call though what ends up happening is that the stock price is going too far one direction and the party that essentially is at risk of having to pay the money they have to put more money down to help cover that position so when we talked about going from a hundred dollars down to seventy so thirty dollar drop there might be a margin call let's say every ten dollars and so as soon as it becomes ninety dollars the broker will call up the other individual and say hey you're essentially losing the position here you need to put more money down for the margin call if not we'll close out the position so what this does is it prevents essentially if it does go down to 30 right and they can't pay that it prevents the other party from losing all $30 if they default on it after the first margin call si $10 what ends up happening is that party will end up losing $10 here so you end up having a loss of $10 but it's far better taking that loss of $10 then letting all other down to 30 in the example and losing a bunch of money so margin calls is what happens when you need to put more margin into the account on that margin is like safety money that helps cover the position again you might end up having to add merge and as it's going down and then if it goes back up for example then you don't need as much margin in the account or as much safety can I go down payment really and then you can kind of remove some of it if you want to but again that's what margin is and this movie's called a margin call and the reason being is that the assets in this movie that are purchased essentially when they move too far and they get a margin call they're required to put more money in and if you can't make that payment right you default okay so that's the first component of the movie is gonna be the margin and the margin call component the second part this is the leverage and so leverage is when you borrow money from somebody else to make an investment the reason you do this is you increase your returns so this is one reason I always emphasize people that you need a risk adjusted return so an example of what leverage is doing here is let's say I invest $100 in some asset and it goes up to 102 right I have two percent profit and I make 2% and I sell it and make two percent okay now if you want to tell it leverage that position so we're gonna double that so we have a leverage of two here let's say I put in $100 and I go to somebody else and they just give me $100 I'm going to borrow from them and I'm gonna give it back with no interest in this case so I get the other hundred dollars and I have two hundred dollars and I put the two hundred dollars in at that one hundred and it goes up to one hundred and two right what's gonna happen is you're gonna make four dollars but what when you subtle operate you're gonna give the hundred dollars back to the other individual but on that position you put $100 in you've got four dollars out even though the stock only went up two dollars so it looks awesome right you can leverage your position so this is what we call adding leverage you're gonna end up having essentially borrowed money that makes the profits much larger than they were reform so you can take a terrible strategy and if it just has a little bit of a profit over time you can like basically take advantage of this and make the profit quite large from enhancing the leverage now the risky parts this is where it comes in with the movie if the opposite occurs so the stock price goes from a hundred dollars down to 98 dollars right you lose two dollars in the first scenario if you put your hundred dollars in goes down - you lost two bucks kind of sucks right but that's how that's how life is so if you borrow that other hundred dollars from someone who lent that to you and you take that now you have two hundred dollars and it goes down 98 dollars you lose four dollars so leverage works both directions when you end up gaining money you can make a lot more when you end up losing money you lose a lotmore so when we look at the story here what it's saying is that so Sullivan works late that night to finish Dale's project and discovers that the current volatility in the firm's portfolio of mortgage-backed securities which is a derivative product has exceeded the historic volatility levels of the positions because of excessive leverage if the portfolio's value decreases by 25% the loss will be greater than the value of the firm itself and the firm will go bankrupt okay so this is where the leverage is coming in here right they took a position they had the money to buy it they could have easily have taken the losses and life would have been fine but somebody decided to leverage this to the point that when you end up having that leverage that loss here it creates big big problems so let's look at our example here again real quick let's say that again the stock price with the asset that's backing this is at 100 bucks let's say you leverage the position though and let's say it drops from 100 to 50 right if you put your own money in at a hundred of no leverage and it drops by 50 you lose 50 bucks so you lost half now if we borrowed that hundred bucks and then we have $200 and it drops by 50 you lose a hundred dollars so ends up happening is you have to take your $100 that you borrowed and you give it back to the person and now you're left with nothing you lost everything okay this is essentially what this scenario is saying inside of the video inside the movie here maybe they even took it larger so instead of saying I don't know this they're saying 25% here so to go from $100 down to zero you need four times the leverage here but in many cases I'm guessing in this they took more than that perhaps so maybe you took six or eight times leverage so instead of borrowing you know 100 bucks you borrowed seven eight hundred dollars and I have this really big chunk of cash but when it goes down you're gonna lose everything so this is how this movie is the premise is working and yes this does happen in real life people make really irresponsible decisions they don't manage their risk correctly but this is what's happening in the movie essentially they took a position they over leveraged the position and now all of a sudden markets are turning and now they need to get out of this position as quickly as possible but the issue is when you have large positions you can't just go out and say like I'm gonna sell everything when it's dropping from say 100 to 50 dollars right you can't get down to like I don't know let's say drop dropping down to 70 dollars so you've lost 30 bucks you can't just dump everything on the market and sell it all right you could do that if you're an individual because you have a few shares but when you're big corporations what's ended up happening is the lot of times these positions are so large so for when you're averaging for example are your position now is huge this position is so large that if you went to dump it people would panic because they would see this massive order saying hey I'm getting out something's wrong the world's ending and then everybody alpha panics and everybody tries to sell at the same time and then the price will tank even further so the movie what they're trying to do is essentially get out in time they're trying to slowly offload all of these positions here and become neutral again so that they don't take that massive loss so that's what's going on in the movie here again the margin call is gonna come they're gonna say we need more money I'm guessing that plays into the movie here and again the leverage is what really kills them because in these positions when you have margin calls you could put more money up and then also that leverage is killing them because now instead of taking a standard loss given the assets they have the leverage is of creating a position where they lose far more than they actually put in so that's how this works I hope that answers your question if you like this video don't forget to subscribe definitely give me the like button if you like the video that really helps this channel anyways thanks for watching and as always until next time [Music]

Channel: Dimitri Bianco

Views: 150,236

Keywords: quant, finance, quantitative, banking, Dimitri, Bianco, Margin Call Movie Explained YouTube, Margin Call Movie Explained, margin call, initial margin, leverage, leverage exaplined, financial leverage explained, trading, movie, profit, loss, stock market, stock market explained, wall street, education, financial education, derivatives, MBS, mortgage backed securities

Id: h7kQhdMabo4

Length: 11min 52sec (712 seconds)

Published: Sun May 10 2020