Why are futures valueless?

Question

I understand that futures exchanges are set up in such a way that traders don't pay cash in order to assume a long position on a futures contract; they simply "enter into" the contract, essentially free of charge. For this reason, futures contracts have no value. However, aren't some futures contracts more desirable than others? And, assuming this is the case, isn't there more demand for some futures than for others? And, since a futures contract is tied up to an underlying asset and assets can become scarce if demand exceeds supply, can't futures contracts become scarce too, resulting in some traders willing to pay cash in order to get them? And even if no futures exchange technically enables futures to be purchased with money, such trades may be carried out informally externally to any exchange thus imbuing the futures contract with value.

Answer 1

I will talk about equity futures. Commodity futures can be slightly different, as I briefly point out.

• Equity futures are standardised exchange-traded instruments.
• Futures on stock indices are especially liquid. The reason for that, is that one cannot simply buy/sell an index as he would buy/sell a single stock because an index is merely a reference value, not a real asset. In practice, to go long/short an index (or a fortiori manage the delta of an option written on such an underlying) futures are the only alternative.
• I don't think it is right to claim that futures are "valueless" (you could say they are "priceless" though). Indeed, although you don't pay any premium for them (let us ommit the initial margin or deposit for simplicity), when you "enter into" a futures contract you commit yourself to something. More specifically, if at time $t$ you buy and hold a future up to its expiration date $T$, you know you will have made/lost $S(T)-F(t,T)$ exactly. Of course you'll experience P&L fluctuations in-between due to the daily variation margins but you will have won/lost this exact amount in total. Thus the value of the contract is somehow subjective: people who think that $S(T)$ will be greater than $F(t,T)$ will tend to buy and vice versa (price discovery mechanism). Obviously, if you offset your position prior to expiry you win/lose $F(t^*,T)-F(t,T)$ where $t^*$ denotes the time at which you sell your future to someone else if you were long. It is worth noting that only a minority of future contracts are actually held up to their expiration date.
• The daily margining process increases the liquidity of future contracts because it reduces counterparty credit risk. Indeed, instead of entering a future contract to earn $S(T)-F(t,T)$ at time $T$, you could earn the exact same amount by entering a forward contract. The difference is that, for a forward (which usually trades OTC), there will be no daily margining (because no dedicated clearing house), hence you will win/lose $S(T)-F(t,T)$ as a single cash flow received/paid upon expiry. In other words, if your counterparty defaults before then, you lose everything. With the variation margins mechanism, at least you will have already been paid what the counterparty owes you up to the default date.
• Finally, the fact that you do not have to pay anything upfront (except for the initial margin), is actually something positive for the various market participants since it offers them greater leverage. Introducing a premium as you suggest would ruin that.

At the end of the day, between people who buy/sell futures to hedge (usually sell side and natural hedgers), people that buy/sell futures because they find them mispriced (usually buy side and speculators), the daily margining process supervised by the clearing house and the leveraging, it is clear that futures' markets developed well over the years.

For more background/practical info you can read this futures trading guide from the CME group.

Before concluding, note that in commodity markets your remark concerning the scarcity of the underlying can have a profound impact on the shape of the futures' curve $F(t,T), \forall T$. See for instance the recent oil-storage contango (you should definitely read about contango vs. backwardation if you haven't).

Answer 2

If you buy from/sell to a counterparty at a premium/discount vs. the market price, the original value of your contact is not 0 - the typical situation where this can happen is if the size of the trade is too big to go through the market without significant impact and/or in the presence of a forced buyer/seller (e.g. margin call etc.). Not all markets allow trading outside of the current bid/ask spread. Note that accounting standards such as IFRS have specific instructions on how to account for such a "day 1 profit or loss".

However this is a very unusual situation and you seem to mix the concepts of price and market value. The former reflects supply and demand (desirability, scarcity to use your words), the latter is an accounting matter. To clear the potential confusion, here is an example.

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Let's say you have $\$1,200$ on your account.

If you buy an ounce of gold for $\$1,200$, you end up with an ounce of gold and no cash. The value of your account is still $\$1,200$.

If alternatively you buy a gold future, you don't use your cash but you don't have the gold yet. Your account still has the cash + a future contract with a market value of $\$0$ and your account value is also $\$1,200$.

If the demand for gold rises and the price increases to $\$1,300$ (let's assume that the price of the future also moves to $\$1,300$ for simplicity):

• in the first case, your ounce of gold is now worth $\$1,300$ => total value of your account: $\$1,300$.
• in the second example, your cash is still worth $\$1,200$ and your future contract now has a market value of $\$100$ => total value of your account: $\$1,300$.

If you then buy a second future, you still have $\$1,200$ of cash, 1 future worth $\$100$ and 1 future worth $\$0$ => total value of your account: still $\$1,300$.

If the market value of a future position is not $\$0$ at the moment you initially buy/sell the contract (in other words, if you bought/sold at a price that is not the current market price), you can make an immediate gain or loss. That is not possible if you bought/sold in the market because by construction the market price is the price of the latest transaction: yours.