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If my understanding is correct, then owning a future essentially means owning a contract which obliges to buy/sell something at a certain time for a certain price.

But what I don't understand is how, in practice, trading futures works. When I look at video's of people trading futures they buy and sell futures just like they would stock; by placing buy and sell orders. But this does not make to me: all stocks of a certain company are equivalent, so of course all can be bought and sold at the same price. But future's are not all the same, since some are contracts for price X, while others are contracts for some different price Y. So if you and me both own a future to buy oil in December of this year, it is very well possible that our futures have different values. So how can futures be traded as a "fixed product" with a "fixed price" just stocks, when future for the same product can vary drastically in value?

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    $\begingroup$ When you "buy" (better phrase would be to go long) a futures contract at some price $X$, you are essentially entering an agreement to buy in the future at $X$. $\endgroup$
    – rubikscube09
    Jun 14, 2021 at 22:16
  • $\begingroup$ The current price you go long at is determined by market forces - someone selling to you is agreeing to deliver the underlying (technically speaking not always) to you in the future at price $X$. $\endgroup$
    – rubikscube09
    Jun 14, 2021 at 22:17
  • $\begingroup$ Oke, but then if I go long at day 1 for price $X_1$, and then go long again at day 2 for price $X_2$, and then at day 3 the price for the future is $Y$. Then the two futures that I own are not of the same value, so how can I sell them in a way that takes into account the fact that the first is a contract at price $X_1$ while the second is a contract at price $X_2$? @rubikscube09 $\endgroup$
    – user2520938
    Jun 14, 2021 at 22:20
  • $\begingroup$ Or if "selling" or I guess going short(?) is just entering into the opposite side of the contract, and thus saying you're willing to sell the product for a certain price, then who takes care of cancelling all my offsetting positions at the expiration of the future? @rubikscube09 $\endgroup$
    – user2520938
    Jun 14, 2021 at 22:23
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    $\begingroup$ @noob2 Oke I see, so the result of that process is that I don't actually have to "sell my contract", but that me "buying an opposite contract" in effect cancels out my initial contract and thus has the same effect as would me selling my initial contract? $\endgroup$
    – user2520938
    Jun 14, 2021 at 22:27

2 Answers 2

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"a contract which obliges [someone] to buy/sell something at a certain time for a certain price"

This correctly describes a forward. A forward contract has a delivery price written in it. So my forward contract entered into today might say I am obliged to buy Gold at 1861 an ounce, while yours which was written a few days ago might say 1802. With each forward contract potentially different it becomes difficult to trade these contracts in a secondary market.

A solution to this was found in Chicago IL in the 19th century (some say it was even earlier in Osaka, Japan) resulting in the creation of Futures Exchanges for trading agricultural products. The exchange standardized the terms of the contract, so that for example 1 contract corresponds to 100 ounces of gold, etc. To solve the "different prices" problem the exchange introduced the "daily marking to market".

At the close of every day publishes the "settlement price" for the contract, based on the average market price in the last few minutes of trading. After the market closes all contracts are effectively rewritten to use this settlement price as the delivery price. The exchange also enforces a process so that the winners and losers in this process compensate each other via cash payments (the so called daily mark to market). So at delivery your delivery price is the latest settlement price. In the meantime you will have received profits (in cash) if the delivery price went up or losses if the delivery price went down.

Effectively this means that the current delivery price is whatever is the consensus in the marketplace. If you want to get out of your commitment you can just enter a commitment in the opposite direction and the exchange will offset the two, leaving you with no position.

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  • $\begingroup$ Thanks! This is exactly the info that made some things make sense in my head. Everybody always emphasises the fact that futures are standardised while forwards are not, and this daily mark to market I had also seen, but now I understand how these things fit together and also resolve my confusion in the OP. $\endgroup$
    – user2520938
    Jun 14, 2021 at 22:34
  • $\begingroup$ I have one small follow up question: since futures are bought and sold, but not created in the process, who creates them and owns them upon creation? $\endgroup$
    – user2520938
    Jun 14, 2021 at 22:54
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    $\begingroup$ Futures are created (and destroyed) in the process of trading. When you buy and someone who has no position sells, the Open Interest (number of long contracts = number of short contracts) increase by one. If you buy and someone who already is long sells to you then the OI does not change as one contract is merely transferred from one person to another. $\endgroup$
    – nbbo2
    Jun 14, 2021 at 23:15
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    $\begingroup$ It's a complicated process - usually the exchange will force you to close your position. You should see what happened in the most recent (April 2020 ) episode of negative oil futures. $\endgroup$
    – rubikscube09
    Jun 14, 2021 at 23:43
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    $\begingroup$ In an extreme case the person will end up in court where they will be told that they owe a large sum of money. To lower the chance of this the person will have had to pass some credit checks (sufficient assets, a good reputation in financial matters) before being authorized to trade futures. $\endgroup$
    – nbbo2
    Jun 14, 2021 at 23:43
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Short answer, trading futures is equivalent to trading a stock, because the futures are indeed equivalent. The only real difference is that the stock is perpetual; but the future expires at a known (but common) point in time.

So imagine I decided that I would (for sh1ts-and-giggles) gamble 1 FCOJ contract (ie orange juice, as per Trading Places) with a different broker every day for a month, flipping a coin for direction at 3.20pm every day (when Grandma died, and she so-loved orange juice). Because of "CounterParty Collatteral" (CCP) rules, I don't have 20 trades a month, with different prices for each broker. The brokers and I settle every trade on the exchange, so the effect for both of us is no different than if we'd bought/sold it from/to the market every time, just like a stock.

There is no difference really, except obviously from the leverage ;-) DEM

[Where, meant in utmost generosity, I think you might benefit from looking at this is in the distinction between forward and futures prices. Forwards will indeed have differing prices; but there is only one futures price for any futures contract, no different than for the underlying stock or ton of OJ ;-)]

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