Are futures contracts created of an thin air?
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Are futures contracts created of an thin air?


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Created March 14th 2020 by PolTrader
Updated March 21st 2020 by bobwest
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Are futures contracts created of an thin air?

 
Poland
 
 
Posts: 5 since Jul 2017
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Are futures contracts created of an thin air or there is some set amount of contracts on exchange? What i want to understand : if there is a buyer and seller can exchange create as many contracts at its necessary so the deall will take place?

I want to understand whole concept of contracts. Ty guys for help

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PolTrader View Post
if there is a buyer and seller can exchange create as many contracts at its necessary so the deall will take place?

This. But remember it's symmetrical. For every buyer there has to be the seller. The exchange is not involved in any of the trades (other than arranging and clearing them). It is not like stocks where there are predetermined number of shares available.

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Poland
 
 
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So this means that there is no limitation for number of contracts, am i right?

Ty for your post.

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Correct.

If you look at most futures price settlement reports you will see a column for "Open Interest". This is the number of contracts currently open. This data is normally delayed by one day.

For example for Eurodollars.... "Prior Day Open Interest"

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https://www.cmegroup.com/trading/interest-rates/stir/eurodollar_quotes_settlements_futures.html

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SMCJB View Post
Correct.

If you look at most futures price settlement reports you will see a column for "Open Interest". This is the number of contracts currently open. This data is normally delayed by one day.

For example for Eurodollars.... "Prior Day Open Interest"

Please register on futures.io to view futures trading content such as post attachment(s), image(s), and screenshot(s).

https://www.cmegroup.com/trading/interest-rates/stir/eurodollar_quotes_settlements_futures.html

Thanks for the useful info @SMCJB . A follow up question:

Does remaining open interest at contract expiration tell us how many contracts are taking delivery?

I haven't given it much thought, but I would suppose that is the case. I don't have silos or oil tanks, so I have never taken delivery on any contracts.

~vmodus

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vmodus View Post
A follow up question:
Does remaining open interest at contract expiration tell us how many contracts are taking delivery?

I theory yes, in practice I'm sure it depends upon the contract. Many contracts are financially settled and do not involve any delivery. Obvious examples are ES/S&P 500. Less obvious examples are HH which is a NG financial lookalike contract - same risk just no physical delivery. My experience in this area is limited to NG and CL and even then it's not something I've done in many years. The exchange requirements for going to delivery in those contracts are quite onerous requiring full cash margining before delivery actually occurs. The exchanges also have something called an "ADP" which stands for alternative delivery procedure, which basically means you and the counterparty agree to go to delivery outside of the exchange. So in reality most deliveries actually get ADP'd rather than go through the exchange delivery mechanism. The one big reason you wouldn't do this is if you were matched with a counterparty and you were not happy with the credit risk. There used to be a report that listed how many contracts went to delivery and how many of them in reality were ADP'd but I can't find it. This report here though does show you how many energy contracts have gone to delivery this year (and by who!)
https://www.cmegroup.com/delivery_reports/EnergiesIssuesAndStopsYTDReport.pdf

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It's important to ponder these things, for sure. But only to a measured amount.

I believe it is helpful to first examine the word itself: Contract. (I understand the language barrier can be formidable, here.)

For the word contract ..think attorney, lawyer.

An agreement between two parties. In this case between a buyer and a seller. That's it. How many contracts can an Attorney come up with? They can do it all day everyday....there is no limit...as long as two parties agree to it, BAM, another contract.

Same exactly with these Futures Contracts..............

Ron



PolTrader View Post
Are futures contracts created of an thin air or there is some set amount of contracts on exchange? What i want to understand : if there is a buyer and seller can exchange create as many contracts at its necessary so the deall will take place?

I want to understand whole concept of contracts. Ty guys for help


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SMCJB View Post
I theory yes, in practice I'm sure it depends upon the contract. Many contracts are financially settled and do not involve any delivery. Obvious examples are ES/S&P 500. Less obvious examples are HH which is a NG financial lookalike contract - same risk just no physical delivery. My experience in this area is limited to NG and CL and even then it's not something I've done in many years. The exchange requirements for going to delivery in those contracts are quite onerous requiring full cash margining before delivery actually occurs. The exchanges also have something called an "ADP" which stands for alternative delivery procedure, which basically means you and the counterparty agree to go to delivery outside of the exchange. So in reality most deliveries actually get ADP'd rather than go through the exchange delivery mechanism. The one big reason you wouldn't do this is if you were matched with a counterparty and you were not happy with the credit risk. There used to be a report that listed how many contracts went to delivery and how many of them in reality were ADP'd but I can't find it. This report here though does show you how many energy contracts have gone to delivery this year (and by who!)
https://www.cmegroup.com/delivery_reports/EnergiesIssuesAndStopsYTDReport.pdf

Cool, thank you for the detailed response! I know you are an energies person, so I figured you may know. I do know that if you take delivery on a grain, you essentially have to pay for storage of the grain (literally a rented silo). And of course the contract itself.

On a related topic, I was reading Trading Sardines by Linda Bradford Raschke a couple weeks ago, and pranked on one of her team members instructing her to let an open oats contract expire so they could take delivery. Funny story.

~vmodus

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While not directly related an indirect hint here is to "understand why something came into existence". It would be easier to deal with lot of things in future if we shift our approach to that as its impossible to know everything about everything.

I suggest you to read light but filled with serious details at the same time

"Money and Power: How Goldman Sachs Came to Rule the World"

Here you will know why hedging vehicles came into existence, why FnO came into existence, why usually financial funds get so big as they do, who/what controls the politics behind the scenes and why usually pension funds end up with bad and very ugly risky positions. It is not technical read just very good average mans guide to possible "Explanation" why he got/gets scr*wed.

 
 
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PolTrader View Post
Are futures contracts created of an thin air or there is some set amount of contracts on exchange? What i want to understand : if there is a buyer and seller can exchange create as many contracts at its necessary so the deall will take place?

I want to understand whole concept of contracts. Ty guys for help

Are futures contracts created out of thin air? Yes.

If you and I agree on something we will both do, that agreement was just created by the two of us saying we would do it. If an agreement can be legally enforced, it is a contract (as a matter of definition.)

So if you go into a futures market on Monday and enter into a contract to sell or buy a stated amount of x ("x" being anything there are futures contracts for), someone else takes the other side, and then those contracts now exist, and they didn't before.

Now, if you are going to fulfill the contract by actually delivering or actually receiving x, then that's another matter. When it's time to do it, you will have to have some of x, if you're going to sell, or enough money to pay for x, if you're going to buy, or it won't happen. What if you don't really want to receive or deliver any x? Do you get stuck for it? No worries, your broker will close you out beforehand if you're not going to go to delivery.

So what happens in between the creation of the contracts and either their closing out or the delivery?

To enter into the contracts in the first place, both the buyer and seller have to put up some cash, called margin, that is enough to cover the expected daily fluctuations in price of the contract. This is because at the end of each trading day, or when you close the position (if you close before the end of the day), your account is marked to market and receives a debit or credit for the actual profit or loss in the market that day. So if you are long x, and the price goes up, you get a cash credit for your profit that day. If it goes down, you get a debit (and you may have to add to your margin, which you have to maintain to keep the position open.) And the people who are short get the reverse.

Why? So that, if you really are going to go to delivery, your final, net cost is locked in at the price of the contract at the moment you entered it. This is because, if you are long (you are contracted to buy), your actual purchase of real x will cost you more if the price has risen, but you will also have gotten these daily credits equal to the price rise, so you effectively only pay the original price (ignoring fees). If price went the other way, your price of actual x will be lower, but you will have been charged every day against the margin in your account, so you will actually end up paying the original amount on a net basis (ignoring fees also.) The opposite applies to shorts (where you are a seller).

The ability to lock in an effective price means that people in the business of buying and selling x can hedge against market price risk, which is something many will make use of.

If you are just a trader in the contracts and don't plan to ever deliver or sell x, then you will eventually close your position by entering an offsetting contract (you will be counted as flat then), and you will have your unhedged profit or loss, which has already hit your account.

So, aside from many details, that's how all this works.

Bob.

When one door closes, another opens.
-- Cervantes, Don Quixote

Last edited by bobwest; March 21st, 2020 at 10:09 AM.
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