Talk:Futures contract
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Question

I came to this article with a specific question, and still don't know the answer - If the question is in fact a real one maybe one of you could include an answer in the article. I watch the price of NYMEX crude every day (and am aware there are other markets, grades) and of course it gets a lot of attention on the news. But I started wondering what proportion of the oil that is used in the world transacts thru these contracts. For example, I could start a company to extract oil in my yard, and sell it on the spot market, or just by a long term (forward?) contract with a buyer. Do big oil companies, who have drilling, refining, and retail operations even just have their own stream with no buying/selling crude at any point? In my ignorance I think the question is important because if the NYMEX contract (and its relatives) represents only a smallish proportion of world oil, are civilians like me actually worried about it? I mean, it might not actually reflect the "price of oil" in any real sense? I have the feeling the question itself might not be meaningful, but could you explain that? I enjoyed the article. Cherrywood (talk) 16:07, 23 November 2007 (UTC)

I have to admit that I cannot give an authoritative answer to this question as I have much more experience and knowledge of trading than of what's called 'Back Room' operations, but it is my recollection and inference from all I know, that it is EXTREMELY rare that a futures contract is exercised. Almost in all cases, positions (someone long or short a contract, someone who has bought or sold) are just closed out by buying or selling a corresponding contract. If one has bought a futures contract, one never takes delivery. One simply sells another coresponding contract and the exchange balances them out. My broker shows all the trades I make all day in my account. For the eMini S&P future which I trade, the end of the day is 3:15-3:45PM Mon-Fri. (Fri to Sun is different.) In that 24 Hour market, all my buys and sells are netted together. The buy and sell prices determine my profit or loss and all that's left is the cash plus any long or short positions (bought or sold contracts) I'm carrying over to the next day. And Mon-Fri, that day starts again in 30 minutes. I get an account statement EVERY DAY and each day starts over with only the balances left.

There really are no actual contracts just as there are no actual stock certificates any more today. (I guess if you want, you can request actual stock certificates, but I bet they make you pay a fortune for them both when you get them and when you turn them in. My parents used to have some, but I've never bothered. What for. I trust my broker. Or at least I trust his compliance officers and insurance company and SEC oversight of the brokerage industry.) Shoot, a good example of this is: Go ask a bank teller for the copy of the agreement between depositors, the bank and the FDIC. That agreement is there. You could get it. It may take a year of research assembling documents, agreements and history, but you could do it. They'll probably just press the alarm button to get rid of you. There is a contract specification which outlines the specifics of each commodity contract, but no one actually gets a piece of paper. (Again, not unless you ask for one for some reason but that's for little old ladies and school children who don't understand the concept.) It's easier to think of positions than contracts any way. If you sell a contract, you're short. If you buy a contract you're long. It's easy to think of entering the market long in terms of buying a contract. But what happens if you want to enter the market short by selling a contract? How do you open a position short? How do you sell a contract you haven't bought yet? That's why it's easier to think of 'taking a position.' You open short. You just sell a contract. I could go into an explanation of what happens, but no one cares about the contractual considerations. It's all formalized. The broker just makes a contract materialize out of thin air for all you care and you sell it. No one ever talks about this because no one cares. That's why it's so hard to find out about all of this and why it seems that no one knows exactly how it works. It doesn't matter in the day to day business of buying and selling. All that maters is at the end of the day you subtract the price of all your buys from the price of all your sells and you either make or lose money. Unless you're a grad school professor or a supreme court judge, no one ever reads about this. You read the literature put out by the exchange and infer this stuff by reading between the lines.

Delivery is EXTREMELY rare because the participants in the futures markets are not producers or consumers as they participate in the futures market. They may in fact be producers or consumers in the OIL market, but participants in the futures markets are only hedgers or speculators as they trade in the futures markets. Suffice it here to say that hedgers are people who wish to lock in a price on a commodity and speculators are people who just want to make some money trading futures. As you see from that, hedgers may in fact be participants in the OIL market also. So too may speculators. But participants in the FUTURES markets need have no connection to the underlying commodity market.

People who produce commodities deliver the commodities to either consumers or storage facilities. People who trade contracts just close out their positions. With the possible exception of a company like Cargill or Archer Daniels Midland (for grain) or (BP for oil) who moves grain around by the millions of freight cars or tens of thousands of supertankers, no one takes delivery of futures contracts and I don't think that even Cargill or BP actually do take or effect delivery on futures contracts either. (I would imagine they have some kind of production and supply contracts with their producers and customers. They both, buyers and sellers may use futures contracts to hedge their production or supply contracts, but they are separate contracts, transactions and businesses. No one takes delivery on the futures contracts. It is restricted to a very few companies at certain locations.)

Because it is so EXTREMELY rare that delivery is made, it is my understanding that as a practical matter NO ONE ever takes delivery or the number is infinitesimally small, the answer to your question is that on the one hand, NONE of the oil used in the world transacts through these contracts.

But the commodities markets and the futures markets are tied together by the price expectation. By the settlement price. The supply and demand of the production market influence the price of the futures contract. The expectation and reality of the futures market guarantees that there always be abundant, free flowing commodities to deliver. That stabilizes and rationalizes the markets. So on the other hand,the price of every last drop of oil in the world transacts through the futures markets because that's where the price is determined. (Even if Moscow gives Bejing, or Caracas gives Washington a few million discount barrels, down the line there's a quid pro quo that balances it out.) It may not seem like it especially when you look at today's oil market, but without futures markets, the prices of commodities can go literally (and I mean very literally) from $0 to 'You ain't GOT enough money' in a day because of an overabundance or dearth of buyers or sellers. You can't corner a financial market because they can just keep buying or selling more contracts. Just ask the Texas Hunt Brothers of 'let's buy every last bar of silver in the world' fame.

Likewise, the bottom can't drop out of a commodity market because each producer, each grain elevator, each miller, each grocery store, each baker can lock in his profit for whatever commodity he uses via the futures and commodity markets. Strictly speaking, I guess the bottom could drop out of the market, but the producers and consumers could use the same markets to protect themselves from the crash. And in practice the markets are so broad and deep that they just don't crash. Not anywhere near like they used to. You may not think so, but what we have now are just severe advances and declines. Nothing like there used to be. In the old days, 50 buyers might roll out of a tavern and find one wagon with 1000 pounds of grain. The price of that wagonload would be all the money in the pocket of the richest buyer or whatever the 10 richest could put together. The next week, 50 wagons might show up with no buyers that month and the rats would get all the grain.

The way to look at it is that somewhere in this world, there is one guy in one office. He sleeps by the phone all day. He never does anything, but he knows how to effect delivery of any commodity. The only reason he's there is that some day, some smartass (another word for arbitrager?) might get the idea that if there really was no way to effect delivery of a commodity, the smartass could get all the money in the world together and try to corner a market (either a product market or a futures market) and generate a disconnect between the futures price and the spot price at contract close. As long as that guy sleeping by the phone is in his office, you can't corner a market and the prices stay in sync because there COULD be a delivery. But no body ever tries to effect or take delivery of any futures contract because that guy sleeping by the phone would have to wake up and carry a carload of grain, or a tanker full of oil, or a million shares of stock from one side of his office to the other one bucket at a time. And he's very highly paid, so nobody wants to fool with him. I think he's a lawyer or a plumber or something. This is the reason physical delivery is restricted by the exchanges. It's expensive, cumbersome and unnecessary. See the section on "non convergence" regarding settlement prices on the first page. As I say below, I'd be willing to bet that less than 0.01% of the contracts traded settle or deliver and I wouldn't be surprised if the number is 100 times smaller than that.

Trust me. I grew up in Chicago. And if you go back to some history books and look at the grain markets before the commodities markets were opened, the prices we have today look steady as the Rock of Gibraltar compared to then. You wonder how the world kept from starving long ago. And I say that with absolutely no interest in commodity markets other than as an occasional speculator. Tgdf (talk) 08:30, 5 December 2007 (UTC)

So, the story is the same for contracts on the NYMEX? The specifications for LSCO and the LSCO Delivery section of the exchange rulebook both contain all kinds of detail about delivery. One would think that physical delivery of the commodity is an important part of futures trading on the exchange. This is what is confusing.

200.14 Delivery (A) Delivery shall be made F.O.B. at any pipeline or storage facility in Cushing, Oklahoma with pipeline access to TEPPCO, Cushing storage or Equilon Pipeline Company LLC Cushing storage

For the purposes of this Rule, the term F.O.B. shall mean a delivery in which the seller: (1) provides light "sweet" crude oil to the point of connection between seller's incoming and buyer's outgoing pipeline or storage facility which is free of all liens, encumbrances, unpaid taxes, fees and other charges; (2) ...

(B) At buyer's option, such delivery shall be made by any of the following methods: <\br>(1) By interfacility transfer ("pumpover") into a designated pipeline or storage facility with access to seller's incoming pipeline or storage facility. <\br>(2) By in-tank transfer of title to the buyer without physical movement of product; if the facility used by the seller allows such transfer, or by in-line transfer or book-out if the seller agrees to such transfer.

But you are saying that, even if I lived in Cushing Oklahoma and had a LSCO well in my back yard, I wouldn't be delivering my oil to the Cushing storage facilities and selling it on the NYMEX futures market.

If the futures market for the commodity no longer functions as a market for delivery of the commodity from producers to users, isn't the market more susceptible to speculation-fueled instability than it was at the time when a large percentage of futures were actually settled by delivery of the underlying commodity? --SV Resolution(Talk) 14:27, 13 May 2008 (UTC)

The market is neither more nor less susceptible to manipulation by speculators. Remember, as long as there are exchange-for-physicals arbitrageurs around, the price of the futures contract can never move far from the cost of the cheapest-to-deliver underlying commodity. So, if you can buy crude oil at Cushing for $125/bbl and pipe it to the Port of New York for another $0.20/bbl, the NY price will not exceed $125.20 for more than a few seconds before the arbs step in. Owen× ☎ 20:36, 13 May 2008 (UTC)

Are there any mechanisms for price discovery OTHER THAN the commodities markets? If I had an oilwell in my back-yard in Cushing, how would I actually sell the physical product? --SV Resolution(Talk) 16:54, 22 May 2008 (UTC)

A question about these "exchange-for-physicals" arbitrageurs: When you buy (or sell) a futures contract, is it decided ahead of time whether the contract will be cash settled or whether you make/take physical delivery? Or is this decision made only at expiration? It seems that it has to be the former because if it were the latter, what if you weren't physically capable of taking delivery (ie, you have no need or use for the actual oil) or you aren't physically capable of making delivery (you don't have the actual oil)? Given that it's decided ahead of time, it seems that there are two parallel markets which do not interact. If most of the market participants aren't physically capable of making/taking delivery, how can these arbitrageurs operate? If the price of a cash-settled contract was way higher than the price of a physically-settled contract, you can't arbitrage it because the person who sold you the expensive cash-settled contract wouldn't want physical delivery so you can't cash in the spread between these two. —Preceding unsigned comment added by 69.211.26.131 (talk) 19:56, 22 June 2008 (UTC)

Thank You

 Got it! Thank you.  Is there a need to clarify this in article?  Anyway, I will sleep tonight. 
Cherrywood (talk)  —Preceding comment was added at 21:59, 10 December 2007 (UTC) 

In the main the article looks good to me. As I said, for the most part, the only people who really care about the underlying details are Supreme Court judges and extremely specialized lawyers who write the contracts and regs. Other than that it's just people buying and selling pieces of paper and they ONLY worry about their bottom line. So much so that I have trouble getting into the part about valuation. My eyes glaze over, by head tilts back, and as I begin to snore a bit of drool may drip from my mouth. That's because anyone who actually trades paper knows that there's one sure way to value paper. Just get a current quote. And with all due respect to the college Profs who come up with those valuation formulas (and I really do respect them, that's not just a jab) the quote is the only valuation that matters. Unless you're in some judges office with a bunch of lawyers and professors trying to hash out a point of law or regulation.
God, this edit system is so cool. I'm just getting into it the last couple of weeks.Tgdf (talk) 19:02, 29 December 2007 (UTC)

Reading through the entries here, it seems that many people, who aren't traders, are very interested in the details.

From your point of view, are the people buying and selling paper doing so through a broker?

--Eet 1024 (talk) 23:48, 26 May 2008 (UTC)

Definition

hi, let's try to make the definition as good as possible. There are a few problems with the one as it was (mainly technical, most readers will find these differences irrelevant).

• the buyer - the term buyer implies a transfer of ownership of soI learned mething already in existence (in this case the contract). In the context of futures it can get very messy. For instance, somone who goes short a contract, is he the seller of a contract? The contract didn't exist before, so how can he sell what didn't exist? Did he issue it himself? Or is he the buyer of a contract which commits him to sell? In the case of securities, if you sell short you do sell something that exists - you sell something that you've borrowed and have promised to give back later. Last but not least, suppose you're short 100 contracts, and buy back 50, i.e. you are the buyer of 50 contracts. That doesn't mean you have to take delivery. Almost all definitions mentioned below avoid the use of the term buyer of a contract.

I'm not sure if I'm missing something else, but for just what's here on this page.....buyer just means he who buys. What the buyer buys is a totally separate question which seems to be the cause for confusion in this section. Discussion of negotiable instruments requires precision in language. Sometimes to the extreme. For instance one can buy a put which is an option to sell. And certainly one can sell anything short. Which means selling something you have not previously purchased. But that you have not previously purchased has no bearing and only confuses the issue. The idea is you buy or you sell. What you buy or sell is totally another question. If you always keep them separate and are clear about action and instrument it is easier to avoid confusion. Tgdf (talk) 09:22, 5 December 2007 (UTC)

• confers .. the right and the obligation - this is a good way of explaining the difference between a future and an option, but it seems rather cumbersome. To my knowledge, saying I've just signed a contract which confers upon me the right and the obligation to buy a house, is the same as I've just signed a contract to buy a house.

Again, precision in language will help here. You are correct that buying a futures contract for a house says, I've just signed a contract which confers upon me the right and the obligation to buy a house, which has the colloquial meaning I've just signed a contract to buy a house. And like a futures contract you can only get out of buying the house by selling the contract at a profit or loss. The futures contract will cost the price of the house even though you may only have to pay the broker the portion of the cost of the contract which can't be margined (borrowed) at the purchase of the contract. The rest of the price would only be paid at delivery (closing in the case of a hours) which of course you wouldn't do because no one takes delivery on futures contracts. The only reason you buy or sell futures contracts is to hedge or speculate. Not because you want to buy or sell a commodity or instrument. If you want to buy wheat, you go to the feed store or the flour mill. Not to Merril Lynch.

However if you were illustrating an option contract, you would say, "I've just signed a contract which contract gives me the right (without the obligation) to buy a house at such and such a price for such and such a time." which even in common language can only be expressed by saying that, "I have the right (without the obligation) to buy a house at such and such a price for such and such a time." And the price of the option for a short period will only be the price the current owner of the house requires to keep the house off the open market for the period of the option which should only be a fraction of the cost of the house. Of course, if you exercise the option and buy the house, you will then, in addition to the cost of the option, have to pay the purchase price for the house. Tgdf (talk) 09:22, 5 December 2007 (UTC)

• underlying security - this only captures very few futures

???? Every contract, future or option has an underlying instrument or commodity. The contracts are only the rights and or obligations to buy. Tgdf (talk) 09:22, 5 December 2007 (UTC)

• delivery date / settlement date etc. Common usage is deliver date & price for futures with physical delivery, final settlement date & price for cash settlement.

In practical terms, these dates are the end of trading dates for that contract when settlement prices are fixed. See "Question" above. In effect, no body takes delivery of futures contracts. I don't know, but I bet it's less than one one hundredth of one percent - .01% (.0001 * X) of all contracts traded. It wouldn't surprise me if it were 100 times less than that.Tgdf (talk) 09:22, 5 December 2007 (UTC)

• the market price on the delivery date - the market price changes constantly, so there is more than one. Also, the price is fixed on the last trading date, which is always a few days (or weeks) before actual delivery date.

Contrary to what your butcher or car dealer would have you believe, there is no such thing as a "Market Price." Nowhere. Not for anything. The only time you see a "Market Price" is when a sale occurs. That market price is then, at that time, for that sale. As soon as the next one sells, there's a whole new market price. Prices fixed on the last day of trading are settlement prices or delivery prices. Tgdf (talk) 09:22, 5 December 2007 (UTC)

Definitions from the glossaries:

• CBOT: A legally binding agreement, made on the trading floor of a futures exchange, to buy or sell a commodity or financial instrument sometime in the future. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity. The only variable is price, which is discovered on an exchange trading floor.
• CME: A standardized agreement, traded on a futures exchange, to buy or sell a commodity at a specified price at a date in the future. Specifies the commodity, quality, quantity, delivery date and delivery point or cash settlement.
• Eurex: A standardized contract for the delivery or receipt of a specific amount of a financial instrument, at a set price, on a certain date in the future.
• CFTC: An agreement to purchase or sell a commodity for delivery in the future: (1) at a price that is determined at initiation of the contract; (2) that obligates each party to the contract to fulfill the contract at the specified price; (3) that is used to assume or shift price risk; and (4) that may be satisfied by delivery or offset.

Other definitions: [1] DocendoDiscimus 10:35, 3 October 2005 (UTC)

Really need a description of the tick size. I don't understand how it's different from contract size, and the link talks about the old ticker tape machine.

--I see your point...

• somone who goes short a contract, is he the seller of a contract? Yes, a writer or grantor is a "seller". Know first that for every buyer (long) there is a seller (short), with that being said, selling short a futures contract, is betting the market price will fall, thus allowing you to buy back or "close" the position at the lower price. Allowing you to keep the price difference. Hedgers such as farmers use this to protect their crop from price declines. If a farmer is 5 months from harvest and the price of corn currently is 2.25 a bushel, and the farmer predicts their will be a glut of corn by harvest time- more product lowers price- he may want to arrange to sell a quantity of that corn now at 2.25bu to secure his price and protect from the price decline. so..If the farmer sold at 2.25bu, who may have bought it (taken the other side), for example Kellogg’s cereal. They would want to buy it cheap, and secure a quantity of corn now in anticipation of price inclines. both have an agreement, or contract. Agricultural commodities aren’t like buying a house, they can only deliver product at certain times, with weather bugs and disease an ever present threat, their pay check depends on the predetermined price at which a futures contract can be bought or sold.

• description of the tick size -Exchanges establish the minimum amount that the price can fluctuate upward or downward. This minimum fluctuation is known as a "tick". Each futures contract is a different size, quantity, valuation ect, so there is not a standard "tick size" that can be applied to all futures contract as a whole...for example Each "tick" for the grain market (soybeans, corn and wheat) is 0.25 cents per bushel, on each 5,000-bushel futures contract.Hu12 16:11, 24 February 2006 (UTC)

On one 5,000-bushel futures contract... what? Both this quote and the article linked to now cut off at the end =(

Corrected Hu12 18:04, 25 March 2006 (UTC)

Clarification / Contradiction

Can someone please explain and make more clear the apparent conflict between these two statements:

• In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price

• Futures are settled at the settlement price fixed on the last trading date of the contract (i.e. at the end).

Sounds to me like the "last trading date" would be the day "in the future" that is supposed to have a pre-set price but the second statement leads me to believe the price is not determined until the last trading day. If these statements are accurate, could these mystery dates please be defined more clearly. Otherwise, please clarify what looks like a conflict. --Risce 13:40, 18 July 2006 (UTC)

I think both are attempts at simplification, and in reality its a bit different. With futures, the underlying instrument is not actually bought by the person who buys the future. What is actually exchanged between buyer and seller is, monthly, a cash flow according to the price change of the underlying. Simplified example: Say product 'A' is worth $100 now. I know I want to sell one next year, and I want to know now what I will get for it. I sell a futures contract for it, and it goes for $100. Next month, the spot price of the product has changed to $95. Now what happens is that the person who bought the future pays the difference, 5$, to me. Every month the price difference is exchanged. If the price goes up, the seller pays to the buyer. Now, say, when the future expires the product has become worth $70. In total the buyer will have transferred $30 to the seller of the future. Now, the seller (me, in the example), can sell the product, on the market, for the spot price of $70. Combined with the 30$ the seller has gotten $100 for the product, as was decided in the contract. The buyer of the future could buy the product for $70, and with the 30$ he has paid me it would cost him $100.

No products have to be actually bought or sold, what we really deal with is cash flow based on price changes, which allows people to hedge, or speculate on price changes. Disclaimer: I do not guarantee this is correct, but it is the way I understand it. I hope its clear. S Sepp 14:58, 18 July 2006 (UTC)

well said S Sepp. Both statements are attempts at simplification. Risce, The actual price is not determined until the last trading date. However prior to that date the price fluctuates up and down due to supply/demand..ect. These fluctuations may hold an advantage for speculators or hedgers who wish to "lock" a current price today if they feel the price on the last trading date will be different. Hu12 20:49, 19 July 2006 (UTC)

S Sepp, you stated "The buyer of the future could buy the product for $70, and with the 30$ he has paid me it would cost him $100." Is the buyer not required to buy this product? From the article: "parties of a "futures contract" must exercise the contract (buy or sell) on the settlement date". Thank you for the clarification, but I think someone who understands this very well should write up this example or a similar one in the article. I don't know if an encyclopia is the place to be simplifying things. Perhaps changing "pre-set price" to "pre-set net cost" and explaining the cash flows would be more accurate. --Risce 17:35, 20 July 2006 (UTC)

??? I own commodity "A", and sell a contract for "A" for June 2008 for $100. So the contract says I should deliver the product on June 7, 2008 and receive $100. But the buyer can unilaterally decide to settle the contract by paying me the difference between the contract price and the spot price? And I STILL have a load of "A" in my basement?

Exactly what options do the buyer and the seller have in terms of delivery? Suppose a farmer wants to sell a crop of spring wheat in June, but the buyer doesn't want to take delivery -- how does the farmer get the wheat out of the way before the corn and soybeans come in? --SV Resolution(Talk) 20:40, 18 September 2007 (UTC)

Settlement

This topic is confusing. It says that settlement is done in 2 ways. Followed by 3 bullet points. The third bullet point, Expiry, is not actually one of the ways in which a futures contract is settled, so I don't think it belongs in the same list with "the 2 ways futures contracts are settled".

I actually came to this article to find out if I could understand what the author of an article at seekingalpha was talking about. And I am as mystified as I was before I came here. Here are my questions. I hope an expert can answer them here.

1. Suppose I buy light, sweet crude on the NYMEX for delivery next month (October 7?). If I still own the contract at expiry, am I required to take delivery? Does that mean someone is going to park an oil truck on my driveway, or does that mean I now owe monthly storage fees to someone else who is actually storing it? Is the owner of the storage facility allowed to say "wait a minute, I sold this stuff, take it away!".
2. If I have bought a commodity contract, can I close it out on or before the expiry and avoid ever taking delivery? This would decrease open interest?
3. Am I allowed to sell naked short commodities futures? That could potentially cause open interest to exceed actual supply, couldn't it?
4. To cover my short, I'd have to buy an equal number of contracts, closing out the contract and resulting in a decrease in open interest?

The writer of the seekingalpha article seems to be saying there is some kind of consipiracy going on, and I am trying to understand the mechanism of the commodities markets to understand the difference between bullish speculation (and covering long positions by closing contracts), short covering, and nefarious collusion.

Your help is much appreciated!

--72.94.157.91 18:54, 18 September 2007 (UTC) --SV Resolution(Talk) 20:10, 18 September 2007 (UTC) (that was me, accidentally logged out!)

I agree that this article is confusing. And, after reading the comments to the seekingalpha article, I think Philip Davis is only making it harder to understand.

I think that this talk page answers your questions in that your bulleted items are how the traders behave.

--Eet 1024 (talk) 21:48, 26 May 2008 (UTC)

What about exchange for physical (EFP)? This is how a contract is initiated. Is this involved in settling a contract when no delivery is actually taken? --SV Resolution(Talk) 12:43, 21 September 2007 (UTC)

Confusing

This article is very confusing:

If Party A and Party B hold a futures contract for A to sell an underlying to B (say), and B sells the contract to Party C on the futures exchange, then is the contract then between Party A and Party C where A now sells the underlying to C or do there now exist two contracts between A and B (A sells to B) and B and C (B then sells to C).

Also in contrast, in the above example can A sell the contract to C, ie. obligating C to now sell the underlying to B (even though C may not own the underlying)?

Also in the above discussion it unclear about the "preset price" Is the price actually preset at the time of creation of the future contract or does it fluctuate up until the settlement date (if the latter is true then surely the "preset price" would just be the spot price of the underlying?)

Is the following example correct?

Party A and Party B agree that A will buy from B (B will sell to A) an underlying for $100 on 01 December.

If at some point before 01 December the spot price of the underlying is $95. Surely then the contract is worthless to A as no third party would want to buy the contract as they would be forced to pay $100 for an asset currently valued at $95. But surely the contract is worth something to B as many third parties would happying sell of an asset worth $95 at $100. Ie. they would buy at $2 and make a $3 profit.

In contrast, if at some point before 01 December the spot price of the underlying is $105. Surely then the contract is worthless to B as no third party would want to buy the contract as they would be forced to sell an asset currently valued at $105 for $100. etc.

Is this how futures work?

Yes, you are confused.

Try reading #1 Question way above and my other edits about the need for extreme precision of language when discussing financial instruments. You are confusing where the contract price is designated.

Options contracts contain a strike price IN the contract. When discussing futures contracts, the only price involved is the price you pay for the contract. You pay up front. You actually own the oil, corn or whatever so you only have to put up enough money to cover any advance or decline in the price of what you bought. That's why futures contracts can be margined so heavily. Otherwise they'd be too expensive to be worth the trouble.

With options contracts, you are only paying for the right not the actual thingy. The right is much more volatile so you have to pony up a higher percentage of the purchase price to guarantee against the higher chance of advance/decline.

An option contract is a right (but not a duty) for a period of time (from purchase to exercise date) to buy (or sell, one, not both) a specified amount of a thingy (thingy is a highly technical scientific term for a little or unique thing) at a (strike) price. All those things (buy/sell, exercise date, thingy&quantity, price) are specified in the contract.

A futures contract is a sale of something right then and there. You've actually bought the thingy. It's just that delivery is in the future. Therefore, a futures contract only contains the future delivery date, the specification of the thingy and the quantity of the thingy. The price is the price you pay for the quantity of the thingy or the piece of paper, however you want to look at it. As I said above, it is easier to think of it as just the piece of paper because nobody takes delivery.

While you're not technically correct that the contract is worthless because the price has declined, if you're the guy who is long the contract (has bought and paid for the contract), in practice, the contract has declined in value and is "worth less" by $5 and is now a hot potato to be tossed to the next guy. On the other hand, if you are short the contract (you have sold and collected money for the contract), the contract has increased in value for you because you will either have to buy a contract (go long) to cover your short position, or you will take delivery (which nobody does) of the thingy and sell it at a profit. If that's confusing, again, go to #1 Question way above and my other edits about how to view the process as taking long and short positions and how they are netted against each other (marked to market) daily by your broker in your account.Tgdf (talk) 19:47, 29 December 2007 (UTC)

This page & "Derivatives"

Just a note that there seems like a lot of overlap. Maybe we should link this back to derivatives as the main page and avoid duplication.--192.147.54.3 07:43, 22 October 2007 (UTC)

Is this for real?

The second paragraph says:

"Both parties of a "futures contract" must fulfill the contract on the settlement date. The seller delivers the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit."

What the heck is a cash-settled future? I had heard, but never understood how a market could function outside of an exchange of goods and services. Hedging, speculating...isn't this just a form of big stakes gambling? My head was spinning so badly, I couldn't get past the first section. Could someone help define this?

At any rate, I think the paragraph can be clarified simply by breaking it down more visually along the lines of:

"Both parties of a "futures contract" must fulfill the contract on the settlement date.

- If the future is based on a tangible commodity, the seller delivers the commodity to the buyer. - If it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit."

Is this where we get the term "to hedge one's bets?" Thanks.Krumhorns (talk) 18:35, 29 January 2008 (UTC)