# Why are futures valueless?

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.

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).

• Thanks for this thoughtful reply. Would it be meaningful to introduce futures prices into the market? If tomorrow a major futures exchange restructures futures trading in such a way that each futures contract has not only the usual delivery price but also an entry price, which is an amount required to be paid for the privilege of entering into the futures contract, and both delivery and entry prices fluctuate with time (in the sense that the market quotes for each kind of futures fluctuate with time). In a market such as this, would futures entry prices converge in the long term to zero? – Evan Aad Mar 22 '16 at 5:24
• When you say Obviously, if you sell prior to expiry you win/lose $F(t^*,T)-F(t,T)$, this is not the absolute win/loss of holding a futures contract from $t$ to $t^*$ but a relative one with the reference to holding the contract from $t$ until $T$ (expiration). I suggest mentioning this explicitly in the post. – Richard Hardy Mar 22 '16 at 17:17
• I don't completely agree with that, see page 23 of the CME group futures guide cmegroup.com/education/files/a-traders-guide-to-futures.pdf, though I forgot to mention that, depending on the exchange convention, you might need to convert $F(t∗,T)−F(t,T)$ to a number of ticks and multiply by the tick value times the number of contracts bought/sold.This document will also answer some of your questions Evan Aad. Personally, I fail to see why paying an upfront premium would be interesting for market participants (how could they benefit from that vs to the current case?). – Quantuple Mar 22 '16 at 20:58
• Note that the example page 15 also tells the same story. – Quantuple Mar 22 '16 at 21:24
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. • "If alternatively you buy a gold future, you don't use your cash but you don't have the gold yet." The fact that I don't have the gold yet is not a good justification in itself for why cash isn't involved in the transaction, since when I buy an option on gold I don't have the gold yet either, but money does change hands. – Evan Aad Mar 23 '16 at 12:30 • Simplistic example: imagine gold spot is$\$1,200$, interest rates are 0 and storing gold is free => the 1 month future trades at 1,200. If you buy that future, you agree to pay $\$1,200$in a month for an ounce of gold. If your future had a non 0 value there would be an obvious arbitrage. If you buy a$\$1,200$ 1 month call on gold you have the right to buy gold for $\$1,200\$ in a month - but if gold prices collapse, you won't have to buy and you will let your option expire and limit your loss. That's why the option has a value and the future doesn't. – assylias Mar 30 '16 at 11:30